UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ≤ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Ñscal year ended December 31, 2004 OR n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Ñle number 1-8198 HSBC FINANCE CORPORATION (Exact name of registrant as speciÑed in its charter) Delaware 86-1052062 (State of incorporation) (I.R.S. Employer IdentiÑcation No.) 2700 Sanders Road Prospect Heights, Illinois 60070 (Address of principal executive oÇces) (Zip Code) (847) 564-5000 Registrant's telephone number, including area code Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered 8.875% Adjustable Conversion-Rate Equity Security Units New York Stock Exchange 6 3 / 4% Notes, due May 15, 2011 New York Stock Exchange 6.875% Notes, due January 30, 2033 New York Stock Exchange 6% Notes, due November 30, 2033 New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ≤ No n Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. n Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Rule 12b-2 of the Act). Yes n No ≤ As of February 25, 2005, there were 50 shares of the registrant's common stock outstanding, all of which are owned by HSBC Investments (North America) Inc. The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore Ñling this Form 10-K with the reduced disclosure format. DOCUMENTS INCORPORATED BY REFERENCE None.
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UNITED STATES SECURITIES AND
EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-K(Mark One)
≤ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the Ñscal year ended December 31, 2004
OR
n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission Ñle number 1-8198
HSBC FINANCE CORPORATION(Exact name of registrant as speciÑed in its charter)
Delaware 86-1052062(State of incorporation) (I.R.S. Employer IdentiÑcation No.)
2700 Sanders Road Prospect Heights, Illinois 60070(Address of principal executive oÇces) (Zip Code)
(847) 564-5000Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
8.875% Adjustable Conversion-Rate Equity Security Units New York Stock Exchange63/4% Notes, due May 15, 2011 New York Stock Exchange
6.875% Notes, due January 30, 2033 New York Stock Exchange6% Notes, due November 30, 2033 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:None
Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements forthe past 90 days. Yes ≤ No n
Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy orinformation statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. n
Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Rule 12b-2 of theAct). Yes n No ≤
As of February 25, 2005, there were 50 shares of the registrant's common stock outstanding, all of whichare owned by HSBC Investments (North America) Inc.
The registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and
is therefore Ñling this Form 10-K with the reduced disclosure format.
Analysis of Credit Loss Reserves Activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 85
Net Interest Margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 87
Reconciliations to GAAP Financial MeasuresÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 90
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 106
Item 8. Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 106
Item 9. Changes in and Disagreements with Accountants on Accounting and FinancialDisclosureÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 175
Item 9A. Controls and ProceduresÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 175
Item 9B. Other Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176
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Part/Item No. Page
Part III
Item 10. Directors and Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176
Item 12. Security Ownership of Certain BeneÑcial Owners and Management and RelatedMatters (Omitted) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 177
Item 13. Certain Relationships and Related Transactions (Omitted) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 177
Item 14. Principal Accountant Fees and ServicesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 177
Part IV
Item 15. Exhibits and Financial Statement Schedules
On March 28, 2003, Household International, Inc. (""Household'') was acquired by HSBC Holdings plc(""HSBC'') by way of merger with H2 Acquisition Corporation (""H2''), a wholly owned subsidiary of HSBC,in a purchase business combination. Following the merger, H2 was renamed ""Household International, Inc.''Subsequently, HSBC transferred its ownership interest in Household to a wholly owned subsidiary, HSBCNorth America Holdings Inc., who subsequently contributed Household to its wholly owned subsidiary,HSBC Investments (North America) Inc.
On December 15, 2004, Household merged with its wholly owned subsidiary, Household Finance Corporation(""HFC''). Following the merger, Household changed its name to HSBC Finance Corporation. The namechange was a continuation of the rebranding of the Household businesses to the HSBC brand. These actionswere taken to establish a single brand in North America to create a stronger platform to advance growth acrossall HSBC business lines. By operation of law, following the merger, all obligations of HFC became directobligations of HSBC Finance Corporation.
General
HSBC Finance Corporation is the principal fund raising company for its subsidiaries. Its subsidiaries primarilyprovide middle-market consumers with several types of loan products in the United States, the UnitedKingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. HSBC Finance Corporationand its subsidiaries may also be referred to in this Form 10-K as ""we,'' ""us'' or ""our.'' We oÅer real estatesecured loans, auto Ñnance loans, MasterCard* and Visa* credit card loans, private label credit card loans andpersonal non-credit card loans. We also initiate tax refund anticipation loans in the United States and oÅerspecialty insurance products in the United States, United Kingdom and Canada. We generate cash to fund ourbusinesses primarily by collecting receivable balances; issuing commercial paper, medium and long term debt;borrowing from HSBC subsidiaries and customers; securitizing and selling consumer receivables; andborrowing under secured Ñnancing facilities. We use the cash generated to invest in and support receivablegrowth, to service our debt obligations and to pay dividends to our parent. At December 31, 2004, we hadapproximately 31,500 employees and over 58 million customers.
2004 Developments
‚ On September 30, 2004, we commenced rebranding the Household businesses to the HSBC brand. Onthat date, signs on each major facility were changed to HSBC, several business units began operatingunder the HSBC name and all communications converted from Household to HSBC. On Decem-ber 15, after Household Finance Corporation was merged into Household International, Inc., thesurviving company was renamed HSBC Finance Corporation. In 2005, the rebranding eÅorts willcontinue with name changes for our Canadian branch oÇces and our domestic auto Ñnance businessand credit card banking subsidiary. Our branch based consumer Ñnance business will retain the HFCand BeneÑcial brands, accompanied by the endorsement signature, ""Member HSBC Group.'' Themove to a single brand in North America will promote increased awareness of HSBC, allowing allHSBC businesses in North America to align themselves to merchants and our suppliers and customers,resulting in a stronger platform for growth.
Following the merger of HFC into HSBC Finance Corporation, HSBC Finance Corporation becamethe principal vehicle for funding the operations of its subsidiaries. With the merger, all previousobligations of HFC became direct obligations of HSBC Finance Corporation. The merger also
* MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of Visa USA, Inc.
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eliminates the need for separate Ñnancial statements by HFC that because of the substantialcommonality of assets, were substantially the same as those of its parent, HSBC Finance Corporation.
‚ On December 22, 2004, our aÇliate, HSBC Bank USA, National Association (""HSBC Bank USA'')received regulatory approval to purchase our domestic private label portfolio, including the retainedinterests associated with securitized private label credit card receivables. The sale of $12.2 billion ofreceivables ($15.6 billion on a managed basis) occurred on December 29, 2004 at a purchase price of$12.4 billion. We retained the related account relationships and entered into an agreement to selladditional domestic private label receivables originated under current and future private label accountsto HSBC Bank USA on a daily basis. Under a separate agreement with HSBC Bank USA, we willcontinue to service the portfolio for a fee. In the fourth quarter, we recorded a gain from the bulk saleof the portfolio, including retained securitization interests, of $663 million ($423 million after-tax).Included in this gain was a release of $505 million of owned credit loss reserves associated with theportfolio.
In future periods, our net interest income, fee income and provision for credit losses for private labelreceivables will be substantially reduced, while other income will substantially increase as reducedsecuritization revenue associated with private label receivables will be more than oÅset by gains fromcontinuing sales of private label receivables and receipt of servicing revenue on the portfolio fromHSBC Bank USA. We anticipate that the net eÅect of these sales could result in a reduction to our2005 net income by up to 10%. The amount of other income recorded will be dependent upon thevolume of new receivables we originate during the year and will be subject to competitive factors as wesign agreements with new merchants and extend agreements with existing merchants. We and HSBCBank USA will consider potential sales of some of our MasterCard and Visa receivables to HSBCBank USA in the future based on the continuing evaluation of the capital and liquidity needs at eachentity.
‚ Upon receipt of regulatory approval for the sale of the domestic private label portfolio, we adoptedcharge-oÅ and account management policies in accordance with the Uniform Retail Credit ClassiÑca-tion and Account Management Policy issued by the Federal Financial Institutions ExaminationCouncil (""FFIEC Policies'') for our domestic private label and MasterCard and Visa credit cardportfolios. The adoption of FFIEC Policies resulted in a reduction to net income of approximately$121 million in the fourth quarter of 2004. We do not expect the adoption of FFIEC Policies for ourdomestic private label and MasterCard and Visa portfolios will have a signiÑcant impact on results ofoperations or cash Öows in future periods.
‚ In the third quarter, we announced our intention to structure all new collateralized funding transactionsas secured Ñnancings. Because existing public MasterCard and Visa credit card transactions werestructured as sales to revolving trusts that require replenishments of receivables to support previouslyissued securities, receivables will continue to be sold to the credit card trusts until the revolving periodsend, the last of which is expected to occur in early 2008 based on current projections. Private labeltrusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of thedaily sale of new domestic private label credit card originated to HSBC Bank USA. We will continueto replenish, at reduced levels, certain non-public personal non-credit card and MasterCard and Visasecurities issued to conduits and record the resulting replenishment gains for a period of time in orderto manage liquidity. Termination of gain on sale treatment for new collateralized funding activityreduced our reported net income under U.S. GAAP in 2004 and will continue to in future periods. In2004, our net interest-only strip receivables, excluding both the mark-to-market adjustment recordedin accumulated other comprehensive income and the private label portion purchased by HSBC BankUSA, decreased $466 million. There was no impact in 2004, however, on cash received from operationsor on U.K. GAAP reported results.
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HSBC Finance Corporation
‚ Funding synergies resulting from our acquisition by HSBC have continued to reduce our reliance ontraditional sources to fund our growth. Because we are now a subsidiary of HSBC, our credit spreadsrelative to Treasuries have tightened compared to those we experienced during the months leading upto the announcement of our acquisition by HSBC. Primarily as a result of these tightened creditspreads, reduced liquidity requirements and lower costs due to shortening the maturity of our liabilities,principally through increased issuance of commercial paper, we recognized cash funding expensesavings of approximately $350 million in 2004 and $125 million in 2003 compared to the funding costswe would have incurred using average spreads from the Ñrst half of 2002. It is anticipated that thesetightened credit spreads and other funding synergies including asset transfers will eventually enableHSBC to realize annual cash funding expense savings, including external fee savings, in excess of$1 billion per year as our existing term debt matures over the course of the next few years.
In April 2004, Fitch Ratings revised our Rating Outlook to Positive from Stable and raised our SupportRating to ""1'' from ""2''. In July 2004, Fitch Ratings raised our Senior Debt Rating to ""A°'' from ""A''and raised our Senior Subordinated Debt Rating and our Preferred Stock Rating to ""A'' from ""A¿''.In December 2004, Fitch Ratings again raised our Senior Debt Rating to ""AA¿'' from ""A°'' and ourcommercial paper rating to ""F1°.'' Also in December 2004, Moody's Investor Service revised ourrating outlook to A1 Positive from A1 Stable.
Restatement
HSBC Finance Corporation has restated its consolidated Ñnancial statements for the previously reportedquarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29,2003 through December 31, 2003. This Form 10-K and the exhibits included herewith include all adjustmentsrelating to the restatement for all such prior periods. Amended Forms 10-Q for the periods ended March 31,2004, June 30, 2004 and September 30, 2004 that reÖect adjustments relating to the restatement will be Ñledwith the Securities and Exchange Commission on or before March 31, 2005.
During the fourth quarter of 2004, as part of HSBC Finance Corporation's preparation for the implementationof International Financial Reporting Standards (""IFRS'') by HSBC from January 1, 2005, we undertook areview of our hedging activities to conÑrm conformity with the accounting requirements of IFRS, which diÅerin several respects from the hedge accounting requirements under U.S. GAAP as set out in Statement ofFinancial Accounting Standards No. 133, ""Accounting for Derivative Instruments and Hedging Activities,''(""SFAS 133''). As a result of this review, management determined that there were some deÑciencies in thedocumentation required to support hedge accounting under U.S. GAAP. These documentation deÑcienciesarose following our acquisition by HSBC. As a consequence of the acquisition, pre-existing hedgingrelationships, including hedging relationships that had previously qualiÑed under the ""shortcut'' method ofaccounting pursuant to SFAS 133, were required to be reestablished. At that time there was some debate inthe accounting profession regarding the detailed technical requirements resulting from a business combina-tion. We consulted with our independent accountants, KPMG LLP, in reaching a determination of what wasrequired in order to comply with SFAS 133. Following this, we took the actions we believed were necessary tomaintain hedge accounting for all of our historical hedging relationships in our consolidated Ñnancialstatements for the period ended December 31, 2003 and those consolidated Ñnancial statements received anunqualiÑed audit opinion.
Management, having determined during the fourth quarter of 2004 that there were certain documentationdeÑciencies, engaged independent expert consultants to advise on the continuing eÅectiveness of the identiÑedhedging relationships and again consulted with our independent accountants, KPMG LLP. As a result of thisassessment, we concluded that a substantial number of our hedges met the correlation eÅectivenessrequirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we alsodetermined in conjunction with KPMG LLP that, although a substantial number of the impacted hedgessatisÑed the correlation eÅectiveness requirement of SFAS 133, there were technical deÑciencies in the
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HSBC Finance Corporation
documentation that could not be corrected retroactively or disregarded notwithstanding the proven eÅective-ness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not metand that hedge accounting was not appropriate during the period these documentation deÑciencies existed. Wehave therefore determined that we should restate all the reported periods since our acquisition by HSBC toeliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair valueswaps entered into after that date. During the period from acquisition through December 31, 2004, we arereporting net income of $3.3 billion. The cumulative impact of the loss of hedge accounting during this periodis to increase reported net income by $113 million.
The resulting accounting does not reÖect the economic reality of our hedging activity and has no impact on thetiming or amount of operating cash Öows or cash Öows under any debt or derivative contract. It does not aÅectour ability to make required payments on our outstanding debt obligations. Furthermore, the restatement hasno impact on our results on a U.K. GAAP basis, which are used in measuring and rewarding performance ofemployees. Finally, our economic risk management strategies have not required amendment. Full details ofthe restatement are set out in Note 3 in the accompanying consolidated Ñnancial statements.
Operations
Our operations are divided into three reportable segments: Consumer, Credit Card Services and International.Our Consumer segment includes our consumer lending, mortgage services, retail services, direct lending andauto Ñnance businesses. Our Credit Card Services segment includes our domestic MasterCard and Visa creditcard business. Our International segment includes our foreign operations in the United Kingdom, Canada, theRepublic of Ireland, the Czech Republic and Hungary. Information about businesses or functions that fallbelow the segment reporting quantitative threshold tests such as our insurance services, taxpayer Ñnancialservices and commercial operations, as well as our treasury and corporate activities, which include fair valueadjustments related to purchase accounting and related amortization, are included under the ""All Other''caption within our segment disclosure.
We monitor our operations and evaluate trends on a managed basis (a non-GAAP Ñnancial measure), whichassumes that securitized receivables have not been sold and are still on our balance sheet. We manage andevaluate our operations on a managed basis because the receivables that we securitize are subjected tounderwriting standards comparable to our owned portfolio, are serviced by operating personnel without regardto ownership and result in a similar credit loss exposure for us. In addition, we fund our operations, review ouroperating results and make decisions about allocating resources, such as employees and capital, on a managedbasis. Because HSBC reports results on a U.K. GAAP basis, management also separately monitors earningsexcluding goodwill amortization and net income under U.K. GAAP (non-GAAP Ñnancial measures).
General
We generally serve non-conforming and nonprime consumers. Such customers are individuals who havelimited credit histories, modest incomes, high debt-to-income ratios, high loan-to-value ratios (for real estatesecured products) or have experienced credit problems caused by occasional delinquencies, prior charge-oÅs,bankruptcy or other credit related actions. These customers generally have higher delinquency and credit lossprobabilities and are charged a higher interest rate to compensate for the additional risk of loss (where theloan is not adequately collateralized to mitigate such additional risk of loss) and the anticipated additionalcollection initiatives that may have to be undertaken over the life of the loan. We also originate and purchasenear-prime real estate secured and auto loans. In our MasterCard and Visa, retail services and internationalbusinesses, we also serve prime consumers either through co-branding or merchant relationships.
We use our centralized underwriting, collection and processing functions to adapt our credit standards andcollection eÅorts to national or regional market conditions. Our underwriting, loan administration andcollection functions are supported by highly automated systems and processing facilities. Our centralizedcollection system is augmented by personalized early collection eÅorts.
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HSBC Finance Corporation
We service each customer with a view to understanding that customer's personal Ñnancial needs. Werecognize that individuals may not be able to timely meet all of their Ñnancial obligations. Our goal is to assistconsumers in transitioning through Ñnancially diÇcult times which may lead to them doing more businesswith our lending subsidiaries. As a result, our policies and practices are designed to be Öexible to maximize thecollectibility of our loans while not incurring excessive collection expenses on loans that have a highprobability of being ultimately uncollectible. Proactive credit management, ""hands-on'' customer care andtargeted product marketing are means we use to retain customers and grow our business.
Consumer
Our consumer lending business is one of the largest subprime home equity originators in the United States asranked by Inside B&C Lending. This business has 1,344 branches located in 46 states, and approximately2.8 million active customer accounts, $48.9 billion in managed receivables and 12,800 employees. It ismarketed under both the HFC and BeneÑcial brand names, each of which cater to a slightly diÅerent type ofcustomer in the middle-market population. Both brands oÅer secured and unsecured loan products, such asÑrst and second lien position closed-end mortgage loans, open-end home equity loans, personal non-credit cardloans, including personal homeowner loans (a secured high loan-to-value product that we underwrite and treatlike an unsecured loan), and sales Ñnance contracts. These products are marketed through our retail branchnetwork, direct mail, telemarketing, strategic alliances and Internet sourced applications and leads.
Our mortgage services business purchases non-conforming Ñrst and second lien position residential mortgageloans, including open-end home equity loans, from a network of over 200 unaÇliated third-party lenders (i.e.,correspondents). This business has approximately $28.8 billion in managed receivables, 280,000 activecustomer accounts and 2,700 employees. Purchases are primarily ""bulk'' acquisitions (i.e., pools of loans) butalso include ""Öow'' acquisitions (i.e., loan by loan), and are made based on our speciÑc underwritingguidelines. As of December 31, 2004, mortgage services serviced approximately $5 billion of receivables forother parties, including HSBC Bank USA. Under agreements with HSBC Bank USA, we source, underwrite,price and service loans purchased by HSBC Bank USA from certain correspondents. We oÅer forwardcommitments to selected correspondent lenders to strengthen our relationship with these lenders and to createa sustainable growth channel for this business. Decision One Mortgage Company, LLC (""Decision One''), asubsidiary of HSBC Finance Corporation, was purchased in 1999 to assist us in understanding the productneeds of mortgage brokers and trends in the mortgage lending industry. Through more than 20 branchlocations, Decision One directly originates mortgage loans sourced by mortgage brokers and sells all loans tosecondary market purchasers, including to our mortgage services business.
Our retail services business is one of the largest providers of third-party private label Ñnancing in the UnitedStates based on managed receivables outstanding. On December 29, 2004, our entire domestic private labelportfolio of approximately $15.6 billion of managed receivables was sold to HSBC Bank USA and agreementswere entered into to sell all future receivables to HSBC Bank USA on a daily basis and to service the portfoliofor HSBC Bank USA for a fee. As a result, we now sell all receivables upon origination but service the entireportfolio on behalf of HSBC Bank USA. Our retail services business has over 70 active merchant relationshipsand we service approximately 15.5 million active customer accounts and have 2,100 employees. AtDecember 31, 2004, the serviced private label portfolio consisted of approximately 16 percent of receivables inthe furniture industry, 33 percent in the consumer electronics industry, 27 percent in the powersport vehicle(snowmobiles, personal watercraft, ATV's and motorcycles) industry and approximately 10 percent in thedepartment store industry. Private label Ñnancing products are generated through merchant retail locations,merchant catalog and telephone sales, direct mail and Internet applications.
Our auto Ñnance business purchases, from a network of approximately 5,200 active dealer relationships, retailinstallment contracts of consumers who do not have access to traditional, prime-based lending sources. Wealso originate and reÑnance auto loans through direct mail solicitations, alliance partners, consumer lendingcustomers and the Internet. At December 31, 2004, this business had approximately $10.1 billion in managed
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HSBC Finance Corporation
receivables, approximately 735,000 active customer accounts and 2,000 employees. Approximately 36% ofauto Ñnance receivables are secured by new vehicles.
Credit Card Services
Our Credit Card Services business includes our MasterCard and Visa receivables in the United States,including The GM Card», the AFL-CIO Union Plus»* (""UP'') credit card, Household Bank, Orchard Bank,and HSBC branded cards. This business has approximately $19.7 billion in managed receivables, 14 millionactive customer accounts and 4,700 employees. According to The Nilson Report, this business is the sixthlargest issuer of MasterCard or Visa credit cards in the United States (based on receivables). The GM Card»,a co-branded credit card issued as part of our alliance with General Motors Corporation (""GM''), enablescustomers to earn discounts on the purchase or lease of a new GM vehicle. The UP card program with theAFL-CIO provides beneÑts and services to members of various national and international labor unions. TheHousehold Bank and Orchard Bank branded credit cards oÅer specialized credit card products to consumersunderserved by traditional providers or are marketed in conjunction with merchant relationships establishedthrough our retail services business. HSBC branded cards are targeted through direct mail at the primemarket. In addition, Credit Card Services services $1.0 billion of receivables held by a subsidiary of HSBCBank USA. New receivables and accounts related to the HSBC Bank USA portfolio are originated byHousehold Bank (SB), N.A., and receivables are sold daily to HSBC Bank USA.
Our MasterCard and Visa business is generated primarily through direct mail, telemarketing, Internetapplications, application displays, promotional activity associated with our aÇnity and co-branding relation-ships, mass-media advertisement (The GM Card») and merchant relationships sourced through our retailservices business. We also cross-sell our credit cards to our existing consumer lending and retail servicescustomers as well as our taxpayer Ñnancial services customers.
Although our relationships with GM and the AFL-CIO enable us to access a proprietary customer base, inaccordance with our agreements with these institutions, we own all receivables originated under the programsand are responsible for all credit and collection decisions as well as the funding for the programs. Theseprograms are not dependent upon any payments, guarantees or credit support from these institutions. As aresult, we are not directly dependent upon GM or the AFL-CIO for any speciÑc earnings stream associatedwith these programs. We believe we have a strong working relationship with GM and the AFL-CIO and in2004, we jointly agreed with the AFL-CIO to extend the term of this successful AÇnity Card Program. Theseagreements do not expire in the near term.
International
Our United Kingdom business is a mid-market consumer lender focusing on customer service through itsbranch locations, and consumer electronics through its retail Ñnance operations and telemarketing. Thisbusiness oÅers secured and unsecured lines of credit, secured and unsecured closed-end loans, retail Ñnanceproducts, insurance products and credit cards (including the GM Card» from Vauxhall and marblesTM, anInternet enabled credit card). We operate in England, Scotland, Wales, Northern Ireland and the Republic ofIreland.
Loans held by our United Kingdom, inclusive of the Republic of Ireland, operation are originated through abranch network consisting of 216 HFC Bank and BeneÑcial Finance branches, merchants, direct mail, brokerreferrals, the Internet and outbound telemarketing. This business has approximately $10.7 billion in managedreceivables, 3.5 million customer accounts and 4,000 employees.
Our Canadian business oÅers real estate secured and unsecured lines of credit, secured and unsecured closed-end loans, insurance products, private label credit cards, retail Ñnance products and auto loans to Canadian
* The Union Plus MasterCard and Visa credit card program is an aÇnity arrangement with Union Privilege under which credit cards are
oÅered to members of unions aÇliated with the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO).
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consumers. In addition, through its trust operations, our Canadian business accepts deposits. These productsare marketed through 115 branch oÇces in 10 provinces, through direct mail, 80 merchant relationships andthe Internet. At December 31, 2004, this business had approximately $2.4 billion in managed receivables, 1.0million customer accounts and 1,200 employees.
We opened oÇces in the Czech Republic and Hungary in 2002 and 2001, respectively, to facilitate theexpansion plans of one of our U.K. merchant alliances. These oÇces have approximately $104 million inmanaged receivables and 340 employees.
All Other
Our insurance services operation distributes credit life, disability and unemployment, accidental death anddisability, term life, whole life, annuities, disability, long term care and a variety of other specialty insuranceproducts to our customers. Such products currently are oÅered throughout the United States and Canada andare target oÅered to customers based upon their particular needs. Insurance is directly written by or reinsuredwith one or more of our subsidiaries.
HSBC Taxpayer Financial Services is the leading U.S. provider of tax-related Ñnancial products to consumersthrough nearly 25,000 unaÇliated professional tax preparer locations and tax preparation software providers.Serving more than 8.2 million customers annually, this business leverages the annual U.S. income tax Ñlingprocess to provide products that oÅer consumers quick and convenient access to funds in the amount of theiranticipated tax refund. This business generated a loan volume of approximately $13.3 billion in 2004.
To help ensure high standards of responsible lending, we provide industry-leading compliance programs forour tax preparer business partners. Key elements of our compliance eÅorts include mandatory onlinecompliance and sales-practice training, expanded tax preparer due diligence processes, and on-going salespractice monitoring to help ensure that our customers are treated fairly and that they understand theirÑnancial choices. Additionally, access to free consumer Ñnancial education resources and a 48-hoursatisfaction guarantee are oÅered to customers, which further enhances our compliance and customer serviceeÅorts.
Our commercial operations are very limited in scope and are expected to continue to decline. We have lessthan $300 million in commercial receivables.
Funding
Our continued success and prospects for growth are largely dependent upon access to the global capitalmarkets. Numerous factors, internal and external, may impact our access to, and the costs associated with,these markets. These factors may include our debt ratings, overall economic conditions, overall capitalmarkets volatility and the eÅectiveness of our management of credit risks inherent in our customer base.
The merger with HSBC has improved our access to the capital markets and lowered our funding costs. Inaddition to providing several important sources of direct funding, our aÇliation with HSBC is also expandingour access to a worldwide pool of potential investors. While these new funding synergies have reduced ourreliance on traditional sources to fund our growth, we are focused on balancing our use of aÇliate and third-party funding sources to minimize funding expense while maximizing liquidity. Because we are now asubsidiary of HSBC and our credit ratings have improved, our credit spreads relative to Treasuries havetightened relative to those we experienced during the months leading up to the announcement of ouracquisition by HSBC. Primarily as a result of these tightened credit spreads, reduced liquidity requirementsand lower costs due to shortening the maturity of our liabilities mainly through the issuance of commercialpaper, we recognized cash funding expense savings of approximately $350 million in 2004 and $125 million in2003 compared to the funding costs we would have incurred using average spreads from the Ñrst half of 2002.It is anticipated that these tightened credit spreads and other funding synergies including assets transfers will
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HSBC Finance Corporation
eventually enable HSBC to realize annual cash funding expense savings, including external fee savings, inexcess of $1 billion per year as our existing term debt matures over the course of the next few years.
For a detailed listing of the ratings that have been assigned to HSBC Finance Corporation and our signiÑcantsubsidiaries as of December 31, 2004, see Exhibit 99.1 to this Form 10-K.
We fund our operations globally and domestically, using a combination of capital market and aÇliate debt,preferred equity, securitizations and sales of consumer receivables and borrowings under secured Ñnancingfacilities. We will continue to fund a large part of our operations in the global capital markets, primarilythrough the use of secured Ñnancings, commercial paper, medium-term notes and long-term debt. We willalso continue to sell certain receivables to HSBC Bank USA. We will continue to use derivative Ñnancialinstruments to hedge our currency and interest rate risk exposure. A description of our use of derivativeÑnancial instruments, including interest rate swaps and foreign exchange contracts, and other quantitative andqualitative information about our market risk is set forth in Item 7. ""Management's Discussion and Analysisof Financial Condition and Results of Operations'' (""2004 MD&A'') under the caption ""Risk Management''and Note 16 of our consolidated Ñnancial statements (""2004 Financial Statements'').
Additional information on our sources and availability of funding are set forth in the ""Liquidity and CapitalResources'' and ""OÅ Balance Sheet Arrangements'' sections of our 2004 MD&A.
Regulation and Competition
Regulation
Consumer Lending. Our consumer Ñnance businesses operate in a highly regulated environment. Thesebusinesses are subject to laws relating to consumer protection, discrimination in extending credit, use of creditreports, privacy matters, disclosure of credit terms and correction of billing errors. They also are subject tocertain regulations and legislation that limit operations in certain jurisdictions. For example, limitations maybe placed on the amount of interest or fees that a loan may bear, the amount that may be borrowed, the typesof actions that may be taken to collect or foreclose upon delinquent loans or the information about a customerthat may be shared. Our consumer branch lending oÇces are generally licensed in those jurisdictions in whichthey operate. Such licenses have limited terms but are renewable, and are revocable for cause. Failure tocomply with these laws and regulations may limit the ability of our licensed lenders to collect or enforce loanagreements made with consumers and may cause our lending subsidiaries to be liable for damages andpenalties.
There also continues to be a signiÑcant amount of legislative activity, nationally, locally and at the state level,aimed at curbing lending practices deemed to be ""predatory''. In addition, states have sought to alter lendingpractices through consumer protection actions brought by state attorneys general and other state regulators.Legislative activity in this area is expected to continue targeting certain abusive practices such as loan""Öipping'' (making a loan to reÑnance another loan where there is no tangible beneÑt to the borrower), fee""packing'' (addition of unnecessary, unwanted and unknown fees to a borrower), ""equity stripping'' (lendingwithout regard to the borrower's ability to repay or making it impossible for the borrower to reÑnance withanother lender), and outright fraud. HSBC Finance Corporation does not condone or endorse any of thesepractices. We continue to work with regulators and consumer groups to create appropriate safeguards to avoidthese abusive practices while allowing our borrowers to continue to have access to credit for personal purposes,such as the purchase of homes, automobiles and consumer goods. As part of this eÅort we have adopted a setof lending best practice initiatives. Increased legislative and regulatory focus is also expected on tax refundanticipation loans. It is possible that broad legislative initiatives will be passed which will impose additionalcosts and rules on our businesses. Although we have the ability to react quickly to new laws and regulations, itis too early to estimate the eÅect, if any, these activities will have on us in a particular locality or nationally.
Banking Institutions. Our credit card banking subsidiary, Household Bank (SB), N.A. (""Household Bank''),is a nationally-chartered "credit card bank' which is also a member of the federal reserve system. Household
11
HSBC Finance Corporation
Bank is subject to regulation, supervision and examination by the OÇce of the Comptroller of the Currency(""OCC''). The deposits of Household Bank are insured by the FDIC, which renders it subject to relevantFDIC regulation.
As a result of our acquisition by HSBC, HSBC Finance Corporation and its subsidiaries became subject tosupervision, regulation and examination by the Board of Governors of the Federal Reserve Board (the""Federal Reserve Board''). HSBC is a bank holding company under the U.S. Bank Holding Company Act of1956 (the ""BHCA'') as a result of its ownership of HSBC Bank USA. On January 1, 2004, HSBC formed anew company to hold all of its North American operations, including HSBC Finance Corporation and itssubsidiaries. This company, HSBC North American Holdings Inc. (""HNAH'') is also a ""bank holdingcompany'' under the BHCA, by virtue of its ownership and control of HSBC Bank USA. HSBC and HNAHare registered as Ñnancial holding companies (""FHC'') under the Gramm-Leach-Bliley Act amendments tothe BHCA, enabling them to oÅer a more complete line of Ñnancial products and services.
The United States is a party to the 1988 Basel Capital Accord and U.S. banking regulatory authorities haveadopted risk-based capital requirements for United States banks and bank holding companies that aregenerally consistent with the Accord. In addition, U.S. bank regulatory authorities have adopted "leverage'capital requirements that generally require United States banks and bank holding companies to maintain aminimum amount of capital in relation to their balance sheet assets (measured on a non-risk-weighted basis).Household Bank is subject to these capital requirements.
Household Bank, like other FDIC-insured banks, may be required to pay assessments to the FDIC for depositinsurance under the FDIC's Bank Insurance Fund. Under the FDIC's risk-based system for setting depositinsurance assessments, an institution's assessments vary according to the level of capital an institution holds,its deposit levels and other factors.
The Federal Deposit Insurance Corporation Improvement Act of 1991 provides for extensive regulation ofdepository institutions such as Household Bank, including requiring federal banking regulators to take "promptcorrective action' with respect to FDIC-insured banks that do not meet minimum capital requirements. AtDecember 31, 2004, Household Bank was well-capitalized under applicable OCC and FDIC regulations.
Our principal United Kingdom subsidiary (HFC Bank Limited, formerly known as HFC Bank plc) is subjectto oversight and regulation by the U.K. Financial Services Authority (""FSA'') and the Central BankFinancial Services Authority of Ireland. We have indicated our intent to the FSA to maintain the regulatorycapital of this institution at speciÑed levels. We do not anticipate that any capital contribution will be requiredfor our United Kingdom bank in the near term. In the Republic of Ireland we are regulated by the IrishFinancial Services Regulatory Authority. In May 2005, new consumer protection laws will be eÅective in theU.K. that may impact proÑtability and operations. These changes will not have a material impact on ourresults.
We also maintain a trust company in Canada, which is subject to regulatory supervision by the OÇce of theSuperintendent of Financial Institutions.
Insurance. Our credit insurance business is subject to regulatory supervision under the laws of the states andprovinces in which it operates. Regulations vary from state to state, and province to province, but generallycover licensing of insurance companies, premium and loss rates, dividend restrictions, types of insurance thatmay be sold, permissible investments, policy reserve requirements, and insurance marketing practices.
Our insurance operations in the United Kingdom are subject to regulatory supervision by the FSA.
Competition
The consumer Ñnancial services industry in which we operate is highly fragmented and intensely competitive.We generally compete with banks, thrifts, insurance companies, credit unions, mortgage lenders and brokers,Ñnance companies, securities brokers and dealers, and other domestic and foreign Ñnancial institutions in the
12
HSBC Finance Corporation
United States, Canada and the United Kingdom. We compete by expanding our customer base throughportfolio acquisitions or alliance and co-branding opportunities, oÅering a variety of consumer loan productsand maintaining a strong service orientation.
Cautionary Statement on Forward-Looking Statements
Certain matters discussed throughout this Form 10-K constitute forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make or approve certainstatements in future Ñlings with the SEC, in press releases, or oral or written presentations by representativesof HSBC Finance Corporation that are not statements of historical fact and may also constitute forward-looking statements. Words such as ""believe'', ""expects'', ""estimates'', ""targeted'', ""anticipates'', ""goal'' andsimilar expressions are intended to identify forward-looking statements but should not be considered as theonly means through which these statements may be made. These matters or statements will relate to ourfuture Ñnancial condition, results of operations, plans, objectives, performance or business developments andwill involve known and unknown risks, uncertainties and other factors that may cause our actual results,performance or achievements to be materially diÅerent from that which was expressed or implied by suchforward-looking statements. Forward-looking statements are based on our current views and assumptions andspeak only as of the date they are made. HSBC Finance Corporation undertakes no obligation to update anyforward-looking statement to reÖect subsequent circumstances or events.
The important factors, many of which are out of our control, which could aÅect our actual results and couldcause our results to vary materially from those expressed in public statements or documents are:
‚ changes in laws and regulations, including attempts by local, state and national regulatory agencies orlegislative bodies to control alleged ""predatory'' lending practices through broad or targeted initiativesaimed at lenders operating in consumer lending markets;
‚ increased competition from well-capitalized companies or lenders with access to government sponsoredorganizations for our consumer segment which may impact the terms, rates, costs or proÑts historicallyincluded in the loan products we oÅer or purchase;
‚ changes in accounting or credit policies, practices or standards, as they may be internally modiÑed fromtime to time or changes as may be required by regulatory agencies or the Financial AccountingStandards Board;
‚ changes to operational practices from time to time, such as determinations to sell receivables from ourprivate label and mortgage services businesses and the potential MasterCard and Visa receivable sale,structuring more securitizations as secured Ñnancings, or changes to our customer account manage-ment policies and practices and risk management/collection practices;
‚ changes in overall economic conditions, including the interest rate environment in which we operate,the capital markets in which we fund our operations, the market values of consumer owned real estatethroughout the United States, recession, employment and currency Öuctuations;
‚ consumer perception of the availability of credit, including price competition in the market segmentswe target and the ramiÑcations or ease of Ñling for personal bankruptcy;
‚ the eÅectiveness of models or programs to predict loan delinquency or loss and initiatives to improvecollections in all business areas, and changes we may make from time to time in these models,programs and initiatives;
‚ continued consumer acceptance of our distribution systems and demand for our loan or insuranceproducts;
‚ changes associated with, as well as the diÇculty in, integrating systems, operational functions andcultures, as applicable, of any organization or portfolio acquired by HSBC Finance Corporation;
‚ a reduction of our debt ratings by any of the nationally recognized statistical rating organizations thatrate these instruments to a level that is below our current rating;
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HSBC Finance Corporation
‚ the costs, eÅects and outcomes of regulatory reviews or litigation relating to our nonprime loanreceivables or the business practices or policies of any of our business units, including, but not limitedto, additional compliance requirements;
‚ increased funding costs resulting from instability in the capital markets and risk tolerance of Ñxedincome investors;
‚ the costs, eÅects and outcomes of any litigation matter that is determined adversely to HSBC FinanceCorporation or its businesses;
‚ the ability to attract and retain qualiÑed personnel to support the underwriting, servicing, collection andsales functions of our businesses;
‚ failure to obtain expected funding from HSBC subsidiaries and clients; and
‚ the inability of HSBC Finance Corporation to manage any or all of the foregoing risks as well asanticipated.
Corporate Governance
HSBC Finance Corporation maintains a website at www.household.com on which we make available, as soonas reasonably practicable after Ñling with or furnishing to the SEC, our annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports. Our website alsocontains our Corporate Governance Standards and committee charters for the Audit, Compensation,Executive and Nominating and Governance Committees of our Board of Directors. We will provide printedcopies of this information at no charge upon written request. Requests should be made to HSBC FinanceCorporation, 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention: Corporate Secretary.
CertiÑcations
In addition to certiÑcations from our Chief Executive OÇcer and Chief Financial OÇcer pursuant toSections 302 and 906 of the Sarbanes-Oxley Act of 2002 (attached to this report on Form 10-K as Exhibits 31and 32), we have also Ñled a certiÑcation with the New York Stock Exchange (the ""NYSE'') from our ChiefExecutive OÇcer certifying that he is not aware of any violation by HSBC Finance Corporation of the NYSEcorporate governance listing standards in eÅect as of February 21, 2005.
Item 2. Properties.
Our operations are located throughout the United States, in 10 provinces in Canada and in the UnitedKingdom, with principal facilities located in Lewisville, Texas; New Castle, Delaware; Brandon, Florida;Jacksonville, Florida; Tampa, Florida; Chesapeake, Virginia; Virginia Beach, Virginia; Hanover, Maryland;Bridgewater, New Jersey; Rockaway, New Jersey; Las Vegas, Nevada; Charlotte, North Carolina; Portland,Oregon; Pomona, California; Chicago, Illinois; Elmhurst, Illinois; Franklin Park, Illinois; Mount Prospect,Illinois; Prospect Heights, Illinois; Schaumburg, Illinois; Vernon Hills, Illinois; Wood Dale, Illinois; Carmel,Indiana; Salinas, California; San Diego, California; London, Kentucky; Sioux Falls, South Dakota; Toronto,Ontario and Montreal, Quebec, Canada; and Windsor, Berkshire, United Kingdom.
Substantially all branch oÇces, divisional oÇces, corporate oÇces, regional processing and regional servicingcenter spaces are operated under lease with the exception of the headquarters building for our UnitedKingdom operations, a credit card processing facility in Las Vegas, Nevada; a processing center in VernonHills, Illinois; servicing facilities in London, Kentucky, Mt. Prospect, Illinois, and Chesapeake, Virginia;oÇces in Birmingham, United Kingdom; and an airplane hanger in Wheeling, Illinois. We believe that suchproperties are in good condition and meet our current and reasonably anticipated needs.
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HSBC Finance Corporation
Item 3. Legal Proceedings.
General
We are parties to various legal proceedings resulting from ordinary business activities relating to our currentand/or former operations. Certain of these actions are or purport to be class actions seeking damages in verylarge amounts. These actions assert violations of laws and/or unfair treatment of consumers. Due to theuncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail in eachinstance. We believe that our defenses to these actions have merit and any adverse decision should notmaterially aÅect our consolidated Ñnancial condition.
Consumer Lending Litigation
During the past several years, the press has widely reported certain industry related concerns that may impactus. Some of these involve the amount of litigation instituted against Ñnance and insurance companiesoperating in certain states and the large awards obtained from juries in those states. Like other companies inthis industry, some of our subsidiaries are involved in a number of lawsuits pending against them in thesestates. The cases, in particular, generally allege inadequate disclosure or misrepresentation of Ñnancing terms.In some suits, other parties are also named as defendants. UnspeciÑed compensatory and punitive damages aresought. Several of these suits purport to be class actions or have multiple plaintiÅs. The judicial climate inthese states is such that the outcome of all of these cases is unpredictable. Although our subsidiaries believethey have substantive legal defenses to these claims and are prepared to defend each case vigorously, a numberof such cases have been settled or otherwise resolved for amounts that in the aggregate are not material to ouroperations. Appropriate insurance carriers have been notiÑed of each claim, and a number of reservations ofrights letters have been received. Certain of the Ñnancing of merchandise claims have been partially coveredby insurance.
In a case decided on March 31, 2004 and published on May 13, the Appellate Court of Illinois, First District(Cook County), ruled in U.S. Bank National Association v. Clark, et al., that certain lenders (which did notinclude any subsidiaries of HSBC Finance Corporation) violated the Illinois Interest Act by imposing pointsand Ñnance charge fees in excess of 3% of the principal amount on loans with an interest rate in excess of 8%.The Appellate Court held for the Ñrst time that when the Illinois legislature made amendments to the late feeprovisions of the Interest Act in 1992, Illinois opted out of the Federal Depository Institutions Deregulationand Monetary Control Act of 1980 (""DIDMCA'') and, in ""certain instances,'' the Federal AlternativeMortgage Transaction Parity Act of 1982 (""AMTPA''). DIDMCA and AMTPA each contain provisions thatpreempt certain state laws unless state legislatures took aÇrmative action to ""opt-out'' of the federalpreemptions within speciÑed time frames. The Court found that as a result of 1992 legislative action, theState's 3% restriction on points and Ñnance charge fees are now enforceable in Illinois. The Appellate Court'sruling reversed the trial court's decision, which had relied on previous opinions of the Illinois AttorneyGeneral, the Illinois OÇce of Banks and Real Estate, and other courts. Should the decision stand and beapplied retroactively throughout Illinois, lenders would be required to make refunds to customers who had aclosed-end real estate secured Ñrst mortgage loan of double the interest paid or contracted for, whichever isgreater. The plaintiÅs in the Clark case Ñled a notice of appeal with the Illinois Supreme Court which thecourt accepted. BrieÑng in the Illinois Supreme Court is underway. Three cases and one counterclaim wereÑled against subsidiaries of HSBC Finance Corporation based upon the Clark decision: Wilkes v. HouseholdFinance Corporation III, et al., Circuit Court of Cook County, Illinois, Chancery Division, Ñled on June 18,2004 (purported class action); Aslam v. Accredited Home Lenders, Inc., et al., Circuit Court of Cook County,Illinois, Chancery Division, Ñled on June 11, 2004 (purported class action); MERS Inc. as nominee forHFC v. Gloss, Circuit Court of DuPage County, Illinois (Ñled as a foreclosure counterclaim in September,2004); and Morris, et al. v. Household Mortgage Services, Inc., U.S. District Court for the Northern Districtof Illinois, Ñled on June 22, 2004. On our motion, the Wilkes case was removed to the Circuit Court of CookCounty, Illinois, however, plaintiÅs Ñled a motion to return the case to the U.S. Bankruptcy Court which wasgranted. We are appealing this remand order. We also served an arbitration demand on plaintiÅ's counsel as
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HSBC Finance Corporation
permitted under the loan documents and Ñled a motion to stay or dismiss the case pending arbitration. TheAslam case was settled for an immaterial amount and was dismissed on October 28, 2004. The portion of theMorris case alleging violations of the Illinois Interest Act was settled for an immaterial amount. The Glossmatter is still pending. At this time, we are unable to quantify the potential impact of the Clark decisionshould it be upheld and receive retroactive application.
Credit Card Litigation
On November 15, 2004, the matter entitled American Express Travel Related Services Company, Inc. v. VisaU.S.A. Inc., et al. was Ñled in the U.S. District Court for the Southern District of New York. This case allegesthat HSBC Finance Corporation, Household Bank (SB), N.A. and others violated Sections 1 and 2 of theSherman Act by conspiring to monopolize and unreasonably restrain trade by allegedly implementing andenforcing an agreement requiring any United States bank that issues Visa or MasterCard general cards torefuse to issue such cards from competitors, such as American Express and Discover. PlaintiÅ seeks adeclaration that defendants in this action (including Visa, MasterCard and other banks belonging to thoseassociations), have violated the antitrust laws, and requests an injunction restraining the defendants, theirdirectors, oÇcers, employees, agents, successors, owners and members from ""continuing or maintaining in anymanner, directly or indirectly, the rules, policies, and agreements at issue,'' and seeks ""full compensation fordamages it has sustained, from each Defendant, jointly, severally,'' for each of plaintiÅ's claims, in an amount""to be trebled according to law, plus interest, attorneys' fees and costs of suit''. On February 18, 2005, theDefendants Ñled a motion to dismiss the complaint for failure to state a cause of action. At this time, we areunable to quantify the potential impact from this action, if any.
Securities Litigation
In August 2002, we restated previously reported consolidated Ñnancial statements. The restatement related tocertain MasterCard and Visa co-branding and aÇnity credit card relationships and a third party marketingagreement, which were entered into between 1992 and 1999. All were part of our Credit Card Servicessegment. In consultation with our prior auditors, Arthur Andersen LLP, we treated payments made inconnection with these agreements as prepaid assets and amortized them in accordance with the underlyingeconomics of the agreements. Our current auditor, KPMG LLP, advised us that, in its view, these paymentsshould have either been charged against earnings at the time they were made or amortized over a shorterperiod of time. The restatement resulted in a $155.8 million, after-tax, retroactive reduction to retainedearnings at December 31, 1998. As a result of the restatement, and other corporate events, including, e.g., the2002 settlement with 50 states and the District of Columbia relating to real estate lending practices, HSBCFinance Corporation, and its directors, certain oÇcers and former auditors, have been involved in various legalproceedings, some of which purport to be class actions. A number of these actions allege violations of federalsecurities laws, were Ñled between August and October 2002, and seek to recover damages in respect ofallegedly false and misleading statements about our common stock. These legal actions have been consoli-dated into a single purported class action, JaÅe v. Household International, Inc., et al., No. 02 C 5893(N.D. Ill., Ñled August 19, 2002), and a consolidated and amended complaint was Ñled on March 7, 2003. OnDecember 3, 2004, the court signed the parties' stipulation to certify a class with respect to the claims broughtunder Û10 and Û20 of the Securities Exchange Act of 1934. The parties stipulated that plaintiÅs will not seekto certify a class with respect to the claims brought under Û11 and Û15 of the Securities Act of 1933 in thisaction or otherwise. The amended complaint purports to assert claims under the federal securities laws, onbehalf of all persons who purchased or otherwise acquired our securities between October 23, 1997 andOctober 11, 2002, arising out of alleged false and misleading statements in connection with our sales andlending practices, the 2002 state settlement agreement referred to above, the restatement and the HSBCmerger. The amended complaint, which also names as defendants Arthur Andersen LLP, Goldman, Sachs &Co., and Merrill Lynch, Pierce, Fenner & Smith, Inc., fails to specify the amount of damages sought. In May2003, we, and other defendants, Ñled a motion to dismiss the complaint. On March 19, 2004, the Courtgranted in part, and denied in part the defendants' motion to dismiss the complaint. The Court dismissed allclaims against Merrill Lynch, Pierce, Fenner & Smith, Inc. and Goldman Sachs & Co. The Court also
16
HSBC Finance Corporation
dismissed certain claims alleging strict liability for alleged misrepresentation of material facts based on statuteof limitations grounds. The claims that remain against some or all of the defendants essentially allege thedefendants knowingly made a false statement of a material fact in conjunction with the purchase or sale ofsecurities, that the plaintiÅs justiÑably relied on such statement, the false statement(s) caused the plaintiÅs'damages, and that some or all of the defendants should be liable for those alleged statements. The Court hasordered that all factual discovery must be completed by January 13, 2006 and expert witness discovery mustbe completed by July 24, 2006.
On June 27, 2003, a case entitled, West Virginia Laborers Pension Trust Fund v. Caspersen, et al., was Ñled inthe Chancery Division of the Circuit Court of Cook County, Illinois as case number 03CH10808. Thispurported class action names as defendants the directors of BeneÑcial Corporation at the time of the 1998merger of BeneÑcial Corporation into a subsidiary of HSBC Finance Corporation, and claims that thosedirectors' due diligence of HSBC Finance Corporation at the time they considered the merger was inadequate.The Complaint claims that as a result of some of the securities law and other violations alleged in the JaÅecase, HSBC Finance Corporation common shares lost value. Pursuant to the merger agreement withBeneÑcial Corporation, we assumed the defense of this litigation. In September of 2003, the defendants Ñled amotion to dismiss which was granted on June 15, 2004 based upon a lack of personal jurisdiction over thedefendants. The plaintiÅs have appealed this decision. In addition, on June 30, 2004, a case entitled,Employer-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Caspersen, et al., was Ñled in the SuperiorCourt of New Jersey, Law Division, Somerset County as Case Number L9479-04. Other than the change inplaintiÅ, the suit is substantially identical to the foregoing West Virginia Laborer's Pension Trust Fund case,and is brought by the same principal law Ñrm which brought that suit. The defendants' motion to dismiss wasgranted on February 10, 2005.
With respect to these securities litigation matters, we believe that we have not, and our oÇcers and directorshave not, committed any wrongdoing and in each instance there will be no Ñnding of improper activities thatmay result in a material liability to us or any of our oÇcers or directors.
Item 4. Submission of Matters to a Vote of Security Holders.
Omitted.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
All 50 shares of HSBC Finance Corporation's outstanding common stock are owned by HSBC Investments(North America) Inc. Consequently, there is no public market in HSBC Finance Corporation's commonstock.
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HSBC Finance Corporation
Item 6. Selected Financial Data.
On March 28, 2003, HSBC Holdings plc (""HSBC'') acquired HSBC Finance Corporation (formerlyHousehold International, Inc.). This resulted in a new basis of accounting reÖecting the fair market value ofour assets and liabilities for the ""successor'' periods beginning March 29, 2003. Information for all""predecessor'' periods prior to the merger is presented using our historical basis of accounting, which impactscomparability to our ""successor'' periods. To assist in the comparability of our Ñnancial results, the""predecessor period'' (January 1 to March 28, 2003) has been combined with the ""successor period''(March 29 to December 31, 2003) to present ""combined'' results for the year ended December 31, 2003.
Mar. 29 Jan. 1Year ended Year ended through through Year ended December 31,Dec. 31, Dec. 31, Dec. 31 Mar. 28,
Risk adjusted revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.30 7.18 7.18 7.64 7.40Consumer two-month-and-over contractual delinquency ÏÏÏÏ 4.24 5.39 5.24 4.46 4.20Reserves as a percent of receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.73 5.20 4.74 3.78 3.65Reserves as a percent of nonperforming loansÏÏÏÏÏÏÏÏÏÏÏÏ 108.4 118.0 112.6 105.0 107.0
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HSBC Finance Corporation
(1) The following table, which contains non-GAAP Ñnancial information is provided for comparison of our operating trends only andshould be read in conjunction with our owned basis GAAP Ñnancial information. For 2004, the operating trends, percentages andratios presented below exclude the $121 million decrease in net income relating to the adoption of Federal Financial InstitutionsExamination Council (""FFIEC'') charge-oÅ policies for our domestic private label and MasterCard/Visa receivables and the$423 million (after-tax) gain on the bulk sale of domestic private label receivables to an aÇliate, HSBC Bank USA, NationalAssociation (""HSBC Bank USA''). For 2003, the operating results, percentages and ratios exclude $167 million (after-tax) of HSBCacquisition related costs and other merger related items and for 2002, exclude the $333 million (after-tax) settlement charge andrelated expenses and the $240 million (after-tax) loss on disposition of Thrift assets and deposits. See ""Basis of Reporting'' and""Reconciliations to GAAP Financial Measures'' in Management's Discussion and Analysis for additional discussion and quantitativereconciliations to the equivalent GAAP basis Ñnancial measure.
Owned basis eÇciency ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 43.4 41.0 36.3 38.4 39.6
Return on average managed assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.12 1.32 1.80 1.82 1.85
Managed basis eÇciency ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42.9 34.1 30.8 34.3 34.5
(2) We monitor our operations and evaluate trends on both an owned basis as shown in our Ñnancial statements and on a managed basis.Managed basis reporting (a non-GAAP Ñnancial measure) assumes that securitized receivables have not been sold and are still on ourbalance sheet. Managed basis information is intended to supplement, and should not be considered a substitute for, owned basisreporting and should be read in conjunction with reported owned basis results. See ""Basis of Reporting'' and ""Reconciliations toGAAP Financial Measures'' for additional discussion and quantitative reconciliations to the equivalent GAAP basis Ñnancial measure.
(3) In 2004, we sold $.9 billion of higher quality non-conforming real estate secured receivables and sold our domestic private labelreceivable portfolio of $12.2 billion ($15.6 billion on a managed basis) to HSBC Bank USA. In 2003, we sold $2.8 billion of higherquality non-conforming real estate secured receivables to HSBC Bank USA and acquired owned basis private label portfolios totaling$1.2 billion ($1.6 billion on a managed basis) and MasterCard and Visa portfolios totaling $.9 billion. In 2002, we sold $6.3 billion ofreal estate secured whole loans from our consumer lending and mortgage services businesses and purchased a $.5 billion private labelportfolio. In 2001, we sold approximately $1 billion of MasterCard and Visa receivables as a result of discontinuing our participation inthe GoldÑsh credit card program and purchased a $.7 billion private label portfolio. In 2000, we acquired real estate secured portfoliostotaling $3.7 billion.
(4) As of December 31, 2004, we had received $35.7 billion in HSBC related funding. As of December 31, 2003, we had received$14.7 billion in HSBC related funding. See Liquidity and Capital Resources for the components of this funding.
(5) In conjunction with the acquisition by HSBC, our 7.625%, 7.60%, 7.50% and 8.25% preferred stock was converted into the right toreceive cash which totaled approximately $1.1 billion. In consideration of HSBC transferring suÇcient funds to make these payments,we issued Series A preferred stock to HSBC on March 28, 2003. Also on March 28, 2003, we called for redemption our $4.30, $4.50and 5.00% preferred stock. In September 2004, HSBC North America Holdings Inc. (""HNAH'') issued a new series of preferredstock to HSBC in exchange for our Series A preferred stock. In October 2004, HSBC Investments (North America) Inc. (""HINO'')issued a new series of preferred stock to HNAH in exchange for our Series A preferred stock.
(6) Common shareholder's equity at December 31, 2004 and 2003 reÖects push-down accounting adjustments resulting from the HSBCmerger.
(7) TETMA, TETMA ° Owned Reserves and tangible common equity to tangible managed assets are non-GAAP Ñnancial ratios thatare used by HSBC Finance Corporation management or certain rating agencies as a measure to evaluate capital adequacy and maydiÅer from similarly named measures presented by other companies. See ""Basis of Reporting'' for additional discussion on the use ofnon-GAAP Ñnancial measures and ""Reconciliations to GAAP Financial Measures'' for quantitative reconciliations to the equivalentGAAP basis Ñnancial measure.
(8) In December 2004, we adopted charge-off and account management policies in accordance with the Uniform Retail Credit Classificationand Account Management Policy issued by the FFIEC for our domestic private label and MasterCard and Visa portfolios. The adoptionof the FFIEC charge-off policies resulted in a reduction to net income of $121 million. See ""Credit Quality'' in Management's Discussionand Analysis and Note 5, ""Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIEC Policies,'' in the accompanyingconsolidated financial statements for further discussion of these policy changes.
(9) The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard and Visa portfolios and subsequent sale ofthe domestic private label portfolio in December 2004 have negatively impacted these ratios. Reserves as a percentage of net charge-oÅs excluding domestic private label charge-oÅs in 2004 and the impact of adopting FFIEC charge-oÅ policies for these portfolios was109.2 percent on an owned basis and 96.0 percent on a managed basis.
21
HSBC Finance Corporation
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Restatement
HSBC Finance Corporation has restated its consolidated Ñnancial statements for the previously reportedquarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29,2003 through December 31, 2003. This Form 10-K and the exhibits included herewith include all adjustmentsrelating to the restatement for all such prior periods. Amended Forms 10-Q for the periods ended March 31,2004, June 30, 2004 and September 30, 2004 that reÖect adjustments relating to the restatement will be Ñledwith the Securities and Exchange Commission on or before March 31, 2005.
During the fourth quarter of 2004, as part of our preparation for the implementation of International FinancialReporting Standards (""IFRS'') by HSBC from January 1, 2005, we undertook a review of our hedgingactivities to conÑrm conformity with the accounting requirements of IFRS, which diÅer in several respectsfrom the hedge accounting requirements under U.S. GAAP as set out in Statement of Financial AccountingStandards No. 133, ""Accounting for Derivatives and Hedging Activities (""SFAS 133''). As a result of thisreview, management determined that there were some deÑciencies in the documentation required to supporthedge accounting under U.S. GAAP. These documentation deÑciencies arose following our acquisition byHSBC. As a consequence of the acquisition, pre-existing hedging relationships, including hedging relation-ships that had previously qualiÑed under the ""shortcut'' method of accounting pursuant to SFAS 133, wererequired to be reestablished. At that time there was some debate in the accounting profession regarding thedetailed technical requirements resulting from a business combination. We consulted with our independentaccountants, KPMG LLP, in reaching a determination of what was required in order to comply with SFAS 133.Following this, we took the actions we believed were necessary to maintain hedge accounting for all of ourhistorical hedging relationships in our consolidated financial statements for the period ended December 31, 2003and those consolidated financial statements received an unqualified audit opinion.
Management, having determined during the fourth quarter of 2004 that there were certain documentationdeÑciencies, engaged independent expert consultants to advise on the continuing eÅectiveness of the identiÑedhedging relationships and again consulted with our independent accountants, KPMG LLP. As a result of thisassessment, we concluded that a substantial number of our hedges met the correlation eÅectivenessrequirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we alsodetermined in conjunction with KPMG LLP that, although a substantial number of the impacted hedgessatisÑed the correlation eÅectiveness requirement of SFAS 133, there were technical deÑciencies in thedocumentation that could not be corrected retroactively or disregarded notwithstanding the proven eÅective-ness of the hedging relationships in place and, consequently, that the requirements of SFAS 133 were not metand that hedge accounting was not appropriate during the period these documentation deÑciencies existed. Wehave therefore determined that we should restate all the reported periods since our acquisition by HSBC toeliminate hedge accounting on all hedging relationships outstanding at March 29, 2003 and certain fair valueswaps entered into after that date. This was accomplished primarily by reclassifying the mark to market of thechanges in fair market value of the aÅected derivative Ñnancial instruments previously classiÑed in either debtor other comprehensive income into current period earnings.
The period to period changes in the fair value of these derivative Ñnancial instruments have been recognized aseither an increase or decrease in our current period earnings through derivative income. As part of therestatement process, we have reclassiÑed all previous hedging results reÖected in interest expense associatedwith the aÅected derivative Ñnancial instruments to derivative income.
22
HSBC Finance Corporation
The cumulative restatement is as follows for the periods presented below:
Restatements to Reported Income
% ChangePre-Tax Tax EÅect After Tax to Reported
(dollars in millions)
March 29, 2003 through December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(97) $ 35 $(62) (4.4)%
Quarter ended March 31, 2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (17) 6 (11) 2.3%
Quarter ended June 30, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 59 (21) 38 9.6%
Quarter ended September 30, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 (2) 3 .9%
During the period from acquisition through September 30, 2004, we reported net income of $2.6 billion. Thecumulative impact of the restatement during this period is to reduce reported net income by $32 million. Theloss of hedge accounting also increased net income by $145 million for the quarter ended December 31, 2004.During the period from acquisition through December 31, 2004, we are reporting net income of $3.3 billion.The cumulative impact of the loss of hedge accounting during this period is to increase reported net income by$113 million.
The resulting accounting does not reÖect the economic reality of our hedging activity and has no impact on thetiming or amount of operating cash Öows or cash Öows under any debt or derivative contract. It does not aÅectour ability to make required payments on our outstanding debt obligations. Furthermore, the restatement hasno impact on our results on a U.K. GAAP basis, which are used in measuring and rewarding performance ofemployees. Finally, our economic risk management strategies have not required amendment.
Executive Overview
Organization and Basis of Reporting
HSBC Finance Corporation (formerly Household International, Inc.) and subsidiaries is an indirect whollyowned subsidiary of HSBC North America Holdings Inc. (""HNAH'') which is a wholly owned subsidiary ofHSBC Holdings plc (""HSBC''). HSBC Finance Corporation may also be referred to in Management'sDiscussion and Analysis of Financial Condition and Results of Operations (""MD&A'') as ""we'', ""us'',or ""our''.
On September 30, 2004, Household International, Inc. (""Household'') commenced the rebranding of themajority of its U.S. and Canadian businesses to the HSBC brand. Businesses previously operating under theHousehold name are now called HSBC. Our branch-based consumer lending business has retained the HFCand BeneÑcial brands, accompanied by the HSBC Group's endorsement signature, ""Member HSBC Group.''The single brand allows HSBC in North America to better align its businesses, providing a stronger platformto service customers and advance growth. The HSBC brand also positions us to expand the products andservices oÅered to our customers. As part of this initiative, we merged with our subsidiary, Household FinanceCorporation, and changed our name to HSBC Finance Corporation in December 2004.
HSBC Finance Corporation provides middle-market consumers with real estate secured loans, auto Ñnanceloans, MasterCard* and Visa* credit card loans, private label credit card loans and personal non-credit cardloans in the United States, the United Kingdom, Canada, the Republic of Ireland, the Czech Republic andHungary. We also initiate tax refund anticipation loans in the United States and oÅer credit and specialtyinsurance products in the United States, the United Kingdom and Canada. We generate cash to fund ourbusinesses primarily by collecting receivable balances; issuing commercial paper, medium and long term debt;borrowing from HSBC subsidiaries and customers; securitizing and selling consumer receivables andborrowing under secured Ñnancing facilities. We use the cash generated to invest in and support receivablegrowth, to service our debt obligations and to pay dividends to our parent.
* MasterCard is a registered trademark of MasterCard International, Incorporated and Visa is a registered trademark of Visa USA, Inc.
23
HSBC Finance Corporation
The acquisition by HSBC on March 28, 2003 resulted in a new basis of accounting reÖecting the fair marketvalue of our assets and liabilities for the ""successor'' periods beginning March 29, 2003. Information for all""predecessor'' periods prior to the merger is presented using our historical basis of accounting, which impactscomparability to our ""successor'' periods beginning March 29, 2003. During 2003, the ""predecessor'' periodcontributed $246 million of net income and the ""successor'' period contributed $1.4 billion of net income. Toassist in the comparability of our Ñnancial results and to make it easier to discuss and understand our results ofoperations, Management's Discussion and Analysis combines the ""predecessor period'' (January 1 toMarch 28, 2003) with the ""successor period'' (March 29 to December 31, 2003) to present ""combined''results for the year ended December 31, 2003.
In addition to owned basis reporting, we also monitor our operations and evaluate trends on a managed basis(a non-GAAP Ñnancial measure), which assumes that securitized receivables have not been sold and are stillon our balance sheet. See ""Basis of Reporting'' for further discussion of the reasons we use this non-GAAPÑnancial measure.
Performance, Developments and Trends
Our net income was $1.9 billion in 2004, $1.6 billion in 2003 and $1.6 billion in 2002. In measuring our results,management's primary focus is on managed receivable growth and operating net income (a non-GAAPÑnancial measure which excludes certain nonrecurring items). See ""Basis of Reporting'' for further discussionof operating net income. Operating net income was $1.6 billion in 2004 compared to $1.8 billion in 2003 and$2.1 billion in 2002. Operating net income declined in 2004 primarily due to higher operating expenses andhigher provision for credit losses due to receivables growth, partially oÅset by higher net interest income andhigher other revenues. Operating expenses increased due to receivables growth, increases in marketingexpenses and higher amortization of intangibles which were established in connection with our acquisition byHSBC. Other revenues increased due to higher derivative income and higher fee and other income, partiallyoÅset by lower securitization revenue due to reduced securitization activity. The increase in net interestincome was due to higher average receivable balances partially oÅset by lower yields on our receivables,particularly in real estate secured, auto Ñnance and personal non-credit card receivables, and by higher interestexpense. Interest expense was higher in 2004 resulting from a larger balance sheet, partially oÅset by a lowercost of funds. Amortization of purchase accounting fair value adjustments increased net income by$128 million in 2004 compared to $92 million in 2003.
Operating net income declined in 2003 compared to 2002 due to higher operating expenses to supportreceivable growth; increased legal and compliance costs; higher amortization of intangibles; lower initialsecuritization activity as a result of the use of alternative funding sources and higher provision for credit lossesas a result of higher charge-oÅs partially oÅset by higher net interest margin and fee income due to receivablegrowth, higher derivative income and lower funding costs.
Owned receivables increased to $106.9 billion at December 31, 2004, a 16 percent increase from Decem-ber 31, 2003. Excluding the impact of the sale of our domestic private label portfolio, owned receivables grew29 percent in 2004 as we experienced growth in all our receivable products with real estate secured receivablesbeing the primary contributor of the growth. Real estate secured receivable levels reÖect sales to HSBC BankUSA in 2004 and 2003 and purchases of correspondent receivables directly by HSBC Bank USA of$2.8 billion during 2004, a portion of which we otherwise would have purchased. Lower securitization levelsalso contributed to the increase in owned receivables in 2004.
Our return on average common shareholder's(s') equity (""ROE'') was 11.0 percent in 2004, compared to10.7 percent in 2003 and 17.3 percent in 2002. The decrease in ROE in both 2004 and 2003 reÖects higheraverage equity levels as a result of push-down accounting resulting from our acquisition by HSBC. Our returnon average owned assets (""ROA'') was 1.57 percent in 2004 compared to 1.46 percent in 2003 and1.62 percent in 2002. On an operating basis, ROE was 9.2 percent in 2004 compared to 11.9 percent in 2003and 23.9 percent in 2002, and ROA was 1.32 percent in 2004 compared to 1.60 percent in 2003 and
24
HSBC Finance Corporation
2.21 percent in 2002. The decline in ROA on an operating basis in 2004 reÖects lower net interest margin andlower securitization revenue. In 2003, the decline reÖects higher operating expenses, higher provisions forcredit losses and lower securitization revenue.
Our owned net interest margin was 7.33 percent in 2004, compared to 7.75 percent in 2003 and 7.57 percent in2002. The decrease in 2004 was due to lower yields on our receivables, particularly real estate secured, autoÑnance and personal non-credit card partially oÅset by lower funding costs. The increase in 2003 wasattributable to lower cost of funds including amortization of purchase accounting fair value adjustments,partially oÅset by lower yields on our receivables, particularly real estate secured receivables. The lower yieldsin 2004 and 2003 reÖect a change in mix with higher levels of near-prime receivables, competitive pressure onpricing and, in 2004, the run-oÅ of higher yielding real estate secured receivables, including second lien loans,largely due to reÑnancing activity.
Our owned basis eÇciency ratio was 41.6 percent in 2004, compared to 42.8 percent in 2003 and 42.6 percentin 2002. Our owned basis eÇciency ratio on an operating basis was 43.4 percent in 2004, compared to41.0 percent in 2003 and 36.3 percent in 2002. In 2004, the increase in the eÇciency ratio on an operatingbasis reÖects higher operating expenses including higher intangible amortization, lower securitization revenueand lower overall yields on our receivables, partially oÅset by higher derivative income. In 2003, higheroperating expenses, including higher intangible amortization, and planned higher legal and compliance costswere partially oÅset by higher net interest margin and higher derivative income.
On December 29, 2004, we sold our domestic private label receivable portfolio, including the retained interestsassociated with securitized private label receivables, to HSBC Bank USA for an aggregate purchase price of$12.4 billion. The domestic private label receivable portfolio sold consisted of receivables with a balance of$12.2 billion ($15.6 billion on a managed basis). We also released credit loss reserves of $505 millionassociated with this portfolio. The purchase price was determined based upon an independent valuationopinion. We retained the customer relationships and by agreement will sell additional domestic private labelreceivable originations generated under current and future private label accounts to HSBC Bank USA on adaily basis at fair market value. We will also service the receivables for HSBC Bank USA for a fee under aservice agreement that was reviewed by the staÅ of the Federal Reserve Board.
We recorded a pre-tax gain from the sale of the domestic private label receivable portfolio, including retainedsecuritization interests, of $663 million, which is reported as gain on bulk sale of private label receivables inour consolidated statement of income. In future periods, our net interest income, fee income and provision forcredit losses for private label receivables will be substantially reduced, while other income will substantiallyincrease as reduced securitization revenue associated with private label receivables will be more than oÅset bygains from continuing sales of private label receivables and receipt of servicing revenue on the portfolio fromHSBC Bank USA. We anticipate that the net eÅect of these sales could result in a reduction to our 2005 netincome by up to 10%. The amount of other income recorded will be dependent upon the volume of newreceivables we originate during the year and will be subject to competitive factors as we sign agreements withnew merchants and extend agreements with existing merchants. We and HSBC Bank USA will considerpotential sales of some of our MasterCard and Visa receivables to HSBC Bank USA in the future based onthe continuing evaluation of the capital and liquidity needs at each entity.
Upon receipt of regulatory approval for the sale of the domestic private label receivable portfolio, we adoptedcharge-oÅ and account management policies in accordance with the Uniform Retail Credit ClassiÑcation andAccount Management Policy issued by the Federal Financial Institutions Examination Council for ourdomestic private label and MasterCard and Visa portfolios (""FFIEC Policies''). The adoption of the FFIECcharge-oÅ policies resulted in a decrease to our net income of $121 million in the fourth quarter of 2004. Wedo not expect the adoption of FFIEC Policies for these portfolios to have a signiÑcant impact on our businessmodel or on our results of operations or cash Öows in future periods. See ""Credit Quality'' in Management'sDiscussion and Analysis and Note 5, ""Sale of Domestic Private Label Receivables and Adoption of FFIECPolicies,'' to the accompanying consolidated Ñnancial statements for further discussion.
25
HSBC Finance Corporation
Because HSBC reports results on a U.K. GAAP basis, management also separately monitors earningsexcluding goodwill amortization and net income under U.K. GAAP (non-GAAP Ñnancial measures). Thefollowing table summarizes U.K. GAAP results:
Year ended March 29 throughDecember 31, 2004 December 31, 2003
Net income Ó U.K. GAAP basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,584 1,387
Credit Quality
Our owned basis two-months-and-over contractual delinquency ratio in 2004 decreased from 5.36 percent to4.07 percent compared to 2003. The decrease is consistent with the improvements in early delinquency trendswe began to experience in the fourth quarter of 2003 as a result of improvements in the economy, betterunderwriting standards and improved credit quality of originations. Dollars of delinquency in 2004 decreasedcompared to 2003 due to the adoption of FFIEC charge-oÅ policies for our domestic private label andMasterCard and Visa portfolios and the subsequent bulk sale of the domestic private label receivable portfolioin December 2004, partially oÅset by higher levels of receivables in 2004. Excluding these factors, dollars ofdelinquency would have increased only modestly despite signiÑcant growth in our owned portfolios asimprovements in credit quality were more than oÅset by growth as securitized levels declined and our interestin the receivables of certain securitization trusts increased.
Net charge-oÅs as a percentage of average consumer receivables for 2004 decreased 6 basis points over 2003despite being negatively impacted by a charge-oÅ of $158 million related to the adoption of FFIEC Policies inthe fourth quarter of 2004 as discussed above. Excluding the charge-oÅ associated with the adoption ofFFIEC Policies, net charge-oÅs as a percentage of average consumer receivables would have decreased22 basis points in 2004. The lower delinquency levels we have been experiencing as a result of an improvingeconomy as well as the impact of improved collection activities and higher levels of average receivables arehaving a positive impact on net charge-oÅs.
During 2004, our credit loss reserves decreased as a result of the bulk sale of our domestic private labelreceivables to HSBC Bank USA. Excluding this sale, owned credit loss reserves would have increased in 2004reÖecting growth in our loan portfolio, including lower securitization levels which result in our interest in thereceivables of certain securitization trusts to increase, partially oÅset by improved credit quality.
Funding and Capital
During 2004, we were less reliant on third party debt and securitization funding as we used proceeds from thesales of real estate secured and private label receivables to HSBC Bank USA and debt issued to aÇliates toassist in the funding of our businesses. Because we are now a subsidiary of HSBC, our credit ratings haveimproved and our credit spreads relative to Treasuries have tightened compared to those we experiencedduring the months leading up to the announcement of our acquisition by HSBC. Primarily as a result of thesetightened credit spreads, reduced liquidity requirements and lower costs due to shortening the maturity of ourliabilities, principally through increased issuance of commercial paper, we recognized cash funding expensesavings in excess of approximately $350 million in 2004 and $125 million in 2003 compared to the fundingcosts we would have incurred using average spreads from the Ñrst half of 2002. It is anticipated that thesetightened credit spreads and other funding synergies including asset transfers will eventually enable HSBC torealize annual cash funding expense savings, including external fee savings, in excess of $1 billion per year asour existing term debt matures over the course of the next few years.
Securitization of consumer receivables has been a source of funding and liquidity for us. Under U.K. GAAPas currently reported by HSBC, our securitizations are treated as secured Ñnancings. In order to align ouraccounting treatment with that of HSBC under U.K. GAAP (and beginning in 2005 International Financial
26
HSBC Finance Corporation
Reporting Standards), we began to structure all new collateralized funding transactions as secured Ñnancingsin the third quarter of 2004. However, because existing public MasterCard and Visa credit card transactionswere structured as sales to revolving trusts that require replenishments of receivables to support previouslyissued securities, receivables will continue to be sold to these trusts until the revolving periods end, the last ofwhich is expected to occur in early 2008 based on current projections. Private label trusts that publicly issuedsecurities will now be replenished by HSBC Bank USA as a result of the daily sale of new domestic privatelabel credit card originations to HSBC Bank USA. We will continue to replenish at reduced levels, certainnon-public personal non-credit card and MasterCard and Visa securities issued to conduits and record theresulting replenishment gains for a period of time in order to manage liquidity. Since our securitizedreceivables have varying lives, it will take several years for these receivables to pay-oÅ and the related interest-only strip receivables to be reduced to zero. The termination of sale treatment on new collateralized fundingactivity reduced our reported net income under U.S. GAAP. In 2004, our net interest-only strip receivables,excluding both the mark-to-market adjustment recorded in accumulated other comprehensive income and theprivate label portion purchased by HSBC Bank USA, decreased $466 million. There was no impact, however,on cash received from operations or on U.K. GAAP reported results.
Tangible shareholder's(s') equity to tangible managed assets (""TETMA'') was 6.68 percent at December 31,2004 and 7.03 percent at December 31, 2003. TETMA ° Owned Reserves was 9.45 percent at December 31,2004 and 9.89 percent at December 31, 2003. Tangible common equity to tangible managed assets was4.67 percent at December 31, 2004 and 5.04 percent at December 31, 2003. Capital levels at December 31,2004 reÖect common stock dividends of $2.6 billion paid to our parent in 2004. These ratios represent non-GAAP Ñnancial ratios that are used by HSBC Finance Corporation management or certain rating agencies toevaluate capital adequacy and may be diÅerent from similarly named measures presented by other companies.See ""Reconciliations to GAAP Financial Measures'' for additional discussion and quantitative reconciliationto the equivalent GAAP basis Ñnancial measure.
Future Prospects
Our continued success and prospects for growth are dependent upon access to the global capital markets.Numerous factors, both internal and external, may impact our access to, and the costs associated with, thesemarkets. These factors may include our debt ratings, overall economic conditions, overall capital marketsvolatility and the eÅectiveness of our management of credit risks inherent in our customer base. Ouracquisition by HSBC has improved our access to the capital markets. It also has given us the ability to useHSBC's liquidity to partially fund our operations and reduce our overall reliance on the debt markets. OuraÇliation with HSBC has also expanded our access to a worldwide pool of potential investors.
Our results are also impacted by general economic conditions, primarily unemployment, underemploymentand interest rates, which are largely out of our control. Because we generally lend to customers who havelimited credit histories, modest incomes and high debt-to-income ratios or who have experienced prior creditproblems, our customers are generally more susceptible to economic slowdowns than other consumers. Asunemployment and underemployment increase, as they have in recent years, a higher percentage of ourcustomers default on their loans and our charge-oÅs increase. Changes in interest rates generally aÅect boththe rates that we charge to our customers and the rates that we must pay on our borrowings. In 2004, theinterest rates that we paid on our debt increased. We have also experienced reduced pricing to our customersfrom a larger portion of our portfolio consisting of near prime receivables, and a higher mix of real estatesecured receivables. ReÑnancing activity has also resulted in a higher rate of run-oÅ of higher yielding realestate secured receivables, including second lien loans. Our ability to adjust our pricing on many of ourproducts reduces our exposure to an increase in interest rates. The primary risks and opportunities to achievingour business goals in 2005, which are largely dependent upon economic conditions, could result in changes toloan volume, charge-oÅ and net interest income.
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HSBC Finance Corporation
Basis of Reporting
Our consolidated Ñnancial statements are prepared in accordance with accounting principles generallyaccepted in the United States (""U.S. GAAP''). Unless noted, the discussion of our Ñnancial condition andresults of operations included in MD&A are presented on an owned basis of reporting.
HSBC Finance Corporation's acquisition by HSBC on March 28, 2003 resulted in a new basis of accountingreÖecting the fair value of our assets and liabilities for the ""successor'' periods beginning March 29, 2003.Information for all ""predecessor'' periods prior to the merger are presented using our historical basis ofaccounting, which impacts comparability with the ""successor'' period beginning March 29, 2003. To assist inthe comparability of our Ñnancial results and to make it easier to discuss and understand our results ofoperations, MD&A combines the ""predecessor'' period (January 1 through March 28, 2003) with the""successor'' period (March 29 through December 31, 2003) to present ""combined'' results for the year endedDecember 31, 2003.
In addition to the GAAP Ñnancial results reported in our consolidated Ñnancial statements, MD&A includesreference to the following information which is presented on a non-GAAP basis:
Operating Results, Percentages and Ratios Certain percentages and ratios have been presented on anoperating basis and have been calculated using ""operating net income,'' a non-GAAP Ñnancial measure.""Operating net income'' is net income excluding certain nonrecurring items shown in the following table:
2004 2003 2002
(in millions)
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,940 $1,603 $1,558
Gain on bulk sale of private label receivables, after taxÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (423) - -
Adoption of FFIEC charge-oÅ policies for domestic private label andMasterCard and Visa portfolios, after tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 121 - -
HSBC acquisition related costs and other merger related items, after taxÏÏÏÏÏ - 167 -
Settlement charge and related expenses, after tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 333
Loss on disposition of Thrift assets and deposits, after tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 240
Operating net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,638 $1,770 $2,131
We believe that excluding these nonrecurring items helps readers of our Ñnancial statements to betterunderstand the results and trends of our underlying business. While we continue to make daily sales of newprivate label receivable originations to HSBC Bank USA, we consider the initial gain on bulk sale of thereceivable portfolio including the retained interests associated with securitized private label receivables asnonrecurring because our results of operations for 2004 also include the net interest income, fee income, creditlosses and securitization revenue generated by the portfolio and the related retained securitization intereststhrough the date of sale on December 29, 2004. On an ongoing basis, net interest income, fee income,provision for credit losses and securitization revenue from this portfolio will be substantially reduced whileother income will substantially increase as reduced securitization revenue associated with private labelreceivables will be more than oÅset by gains from continuing sales of private label receivables and servicingrevenue on the portfolio received from HSBC Bank USA.
Managed Basis Reporting We monitor our operations and evaluate trends on a managed basis (a non-GAAPÑnancial measure), which assumes that securitized receivables have not been sold and are still on our balancesheet. We manage and evaluate our operations on a managed basis because the receivables that we securitizeare subjected to underwriting standards comparable to our owned portfolio, are serviced by operatingpersonnel without regard to ownership and result in a similar credit loss exposure for us. In addition, we fundour operations, review our operating results, and make decisions about allocating resources such as employeesand capital on a managed basis.
28
HSBC Finance Corporation
When reporting on a managed basis, net interest income, provision for credit losses and fee income related toreceivables securitized are reclassiÑed from securitization revenue in our owned statement of income into theappropriate caption. Additionally, charge-oÅ and delinquency associated with these receivables are included inour managed basis credit quality statistics.
Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasonsdiscussed above and have historically requested managed basis information from us. We believe that managedbasis information enables investors and other interested parties to better understand the performance andquality of our entire loan portfolio and is important to understanding the quality of originations and the relatedcredit risk inherent in our owned and securitized portfolios. As the level of our securitized receivables fallsover time, managed basis and owned basis results will eventually converge, and we will only report owned basisresults.
Equity Ratios Tangible shareholder's equity to tangible managed assets (""TETMA''), tangible shareholder'sequity plus owned loss reserves to tangible managed assets (""TETMA ° Owned Reserves'') and tangiblecommon equity to tangible managed assets are non-GAAP Ñnancial measures that are used by HSBC FinanceCorporation management and certain rating agencies to evaluate capital adequacy. These ratios may diÅerfrom similarly named measures presented by other companies. The most directly comparable GAAP Ñnancialmeasure is common and preferred equity to owned assets.
We and certain rating agencies also monitor our equity ratios excluding the impact of purchase accountingadjustments. We do so because we believe that the purchase accounting adjustments represent non-cashtransactions which do not aÅect our business operations, cash Öows or ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered equity in the TETMA andTETMA ° Owned Reserves calculations because of their long-term subordinated nature and the ability todefer dividends. Our Adjustable Conversion-Rate Equity Security Units, adjusted for purchase accountingadjustments, are also considered equity in these calculations because they include investor obligations topurchase HSBC ordinary shares in 2006.
U.K. GAAP Because HSBC reports results on a U.K. GAAP basis, our management also separately monitorsnet income and earnings excluding goodwill amortization under U.K. GAAP (non-GAAP Ñnancial mea-sures). The following table reconciles our net income on a U.S. GAAP basis to earnings excluding goodwillamortization and net income on a U.K. GAAP basis:
Year ended March 29 throughDecember 31, 2004 December 31, 2003
(Restated)(in millions)
Net income Ó U.S. GAAP basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,940 $1,357
Net income Ó U.K. GAAP basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,584 1,387
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HSBC Finance Corporation
DiÅerences between U.S. and U.K. GAAP are as follows:
Loan origination
U.K. GAAP‚ Fee and commission income is accounted for in the period when receivable, except when it is charged
to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. Inthese cases, it is recognized on an appropriate basis over the relevant period.
‚ Loan origination costs are generally expensed as incurred. As permitted by U.K. GAAP, HSBC appliesa restricted deÑnition of the incremental, directly attributable origination expenses that are deferredand subsequently amortized over the life of the loans.
U.S. GAAP‚ Certain loan fee income and direct loan origination costs are amortized to the proÑt and loss account,
on a straight-line basis, over the life of the loan as an adjustment to interest income (Statement ofFinancial Accounting Standard (""SFAS'') 91, ""Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct Costs of Leases''.) Prepayment anddelinquency estimates are regularly monitored and fee and cost amortization rates adjustedaccordingly.
‚ Credit card annual fees are netted with direct lending costs, deferred, and amortized on a straight-linebasis over one year.
Derivatives
U.K. GAAP‚ Non-trading derivatives are those which are held for hedging purposes as part of our risk management
strategy against cash Öows, assets, liabilities, or positions measured on an accruals basis. Non-tradingtransactions include qualifying hedges and positions that synthetically alter the characteristics ofspeciÑed Ñnancial instruments.
‚ Non-trading derivatives are accounted for on an equivalent basis to the underlying assets, liabilities ornet positions. Any proÑt or loss arising is recognized on the same basis as that arising from the relatedassets, liabilities or positions.
‚ To qualify as a hedge, a derivative must eÅectively reduce the price, foreign exchange or interest raterisk of the asset, liability or anticipated transaction to which it is linked and be designated as a hedge atinception of the derivative contract. Accordingly, changes in the market value of the derivative must behighly correlated with changes in the market value of the underlying hedged item at inception of thehedge and over the life of the hedge contract. If these criteria are met, the derivative is accounted foron the same basis as the underlying hedged item. Derivatives used for hedging purposes include swaps,forwards and futures.
‚ Interest rate swaps are also used to alter synthetically the interest rate characteristics of Ñnancialinstruments. In order to qualify for synthetic alteration, a derivative instrument must be linked tospeciÑc individual, or pools of similar, assets or liabilities by the notional principal and interest rate riskof the associated instruments, and must achieve a result that is consistent with deÑned riskmanagement objectives. If these criteria are met, accrual based accounting is applied, i.e. income orexpense is recognized and accrued to the next settlement date in accordance with the contractual termsof the agreement.
‚ Any gain or loss arising on the termination of a qualifying derivative is deferred and amortized toearnings over the original life of the terminated contract. Where the underlying asset, liability orposition is sold or terminated, the qualifying derivative is immediately marked-to-market through theproÑt and loss account.
‚ Derivatives that do not qualify as hedges or synthetic alterations at inception are marked-to-marketthrough the proÑt and loss account, with gains and losses included within ""other income''.
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HSBC Finance Corporation
U.S. GAAP‚ All derivatives must be recognized as either assets or liabilities in the balance sheet and be measured at
fair value (SFAS 133, ""Accounting for Derivative Instruments and Hedging Activities'').‚ The accounting for changes in the fair value of a derivative (i.e., gains and losses) depends on the
intended use of the derivative and the resulting designation as described below:Ó For a derivative designated as hedging exposure to changes in the fair value of a recognized asset or
liability or a Ñrm commitment, the gain or loss is recognized in earnings in the period of changetogether with the associated loss or gain on the hedged item attributable to the risk being hedged.Any resulting net gain or loss represents the ineÅective portion of the hedge.
Ó For a derivative designated as hedging exposure to variable cash Öows of a recognized asset orliability, or of a forecast transaction, the derivative's gain or loss associated with the eÅective portionof the hedge is initially reported as a component of other comprehensive income and subsequentlyreclassiÑed into earnings when the forecast transaction aÅects earnings. The ineÅective portion isreported in earnings immediately.
Ó For net investment hedges in which derivatives hedge the foreign currency exposure of a netinvestment in a foreign operation, the change in fair value of the derivative associated with theeÅective portion of the hedge is included as a component of other comprehensive income (""OCI''),together with the associated loss or gain on the hedged item. The ineÅective portion is reported inearnings immediately.
Ó In order to apply hedge accounting it is necessary to comply with documentation requirements andto demonstrate the eÅectiveness of the hedge on a retrospective and prospective basis.
Ó For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings inthe period of change in fair value.
Securitizations
U.K. GAAP‚ Financial Reporting Standard (""FRS'') 5, ""Reporting the Substance of Transactions,'' requires that
the accounting for securitized receivables is governed by whether the originator has access to thebeneÑts of the securitized assets and exposure to the risks inherent in those beneÑts and whether theoriginator has a liability to repay the proceeds of the note issue:Ó The securitized assets should be derecognized in their entirety and a gain or loss on sale recorded
where the originator retains no signiÑcant beneÑts and no signiÑcant risks relating to thosesecuritized assets.
Ó The securitized assets and the related Ñnance should be consolidated under a linked presentationwhere the originator retains signiÑcant beneÑts and signiÑcant risks relating to those securitizedassets but where the downside exposure is limited to a Ñxed monetary amount and certain otherconditions are met.
Ó The securitized assets and the related Ñnance should be consolidated on a gross basis where theoriginator retains signiÑcant beneÑts and signiÑcant risks relating to those securitized assets and doesnot meet the conditions required for linked presentation.
U.S. GAAP‚ SFAS 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,'' requires that receivables that are sold to a special purpose entity and securitized can onlybe derecognized and a gain or loss on sale recognized if the originator has surrendered control overthose securitized assets.
‚ Control has been surrendered over transferred assets if and only if all of the following conditions aremet:Ó The transferred assets have been put presumptively beyond the reach of the transferor and its
creditors, even in bankruptcy or other receivership.
31
HSBC Finance Corporation
Ó Each holder of interests in the transferee (i.e., holder of issued notes) has the right to pledge orexchange their beneÑcial interests, and no condition constrains this right and provides more than atrivial beneÑt to the transferor.
Ó The transferor does not maintain eÅective control over the assets through either an agreement thatobligates the transferor to repurchase or to redeem them before their maturity or through the abilityto unilaterally cause the holder to return speciÑc assets, other than through a clean-up call.
Ó If these conditions are not met the securitized assets should continue to be consolidated.‚ Where we retain an interest in the securitized assets, such as a servicing right or the right to residual
cash Öows from the special purpose entity, we recognize this interest at fair value on sale of the assets.‚ There are no provisions for linked presentation of securitized assets and the related Ñnance.
Intangible assets
U.K. GAAP‚ An intangible asset is recognized separately from goodwill where it is identiÑable and controlled. It is
identiÑable only if it can be disposed of or settled separately without disposing of the whole business.Control requires legal rights or custody over the item.
‚ An intangible asset purchased as part of a business combination is capitalized at fair value based on itsreplacement cost, which is normally its estimated market value.
U.S. GAAP‚ An intangible asset is recognized separately from goodwill when it arises from contractual or other legal
rights or if it is separable, i.e. it is capable of being separated or divided from the acquired entity andsold, transferred, licensed, rented, or exchanged in combination with a related contract, asset orliability. The eÅect of this is that certain intangible assets such as trademarks and customerrelationships are recognized under U.S. GAAP, although such assets will not be recognized underU.K. GAAP.
‚ Intangible assets are initially recognized at fair value. An intangible asset with a Ñnite useful life isamortized on a straight-line basis over the period for which it contributes to the future cash Öows of theentity. An intangible asset with an indeÑnite useful life is not amortized but is tested for impairmentannually or more frequently if events or changes in circumstances indicate that the asset might beimpaired.
Purchase accounting adjustments Ó The reconciling ""purchase accounting adjustments'' predominantly reÖect:‚ the measurement of equity consideration at the date the terms of acquisition are agreed and announced
under U.S. GAAP; under U.K. GAAP equity consideration is measured at the date of acquisition;‚ recognition of deferred tax on all fair value adjustments under U.S. GAAP, and corresponding
amortization post-acquisition;‚ non-recognition of residual interests in securitization vehicles existing at acquisition under
U.K. GAAP. Instead, the assets and liabilities of the securitization vehicles are recognized on theU.K. GAAP balance sheet, and credit provisions are established against the loans and advances. ThisGAAP adjustment existing at acquisition unwinds over the life of the securitization vehicles; and
‚ certain costs which under U.K. GAAP, relate to either post-acquisition management decisions orcertain decisions made prior to the acquisition are required to be expensed to the post-acquisition proÑtand loss account and cannot be capitalized as goodwill, or included within the fair value of theliabilities of the acquired entity.
Other Ó Includes adjustments related to suspension of interest accruals on nonperforming loans, capitalizedsoftware costs and other items.
‚ Capitalized software costsÓ U.K. GAAP Ó HSBC generally expenses costs of software developed for internal use. If it can be
shown that conditions for capitalization are met under FRS 10, ""Goodwill and intangible assets,'' orFRS 15, ""Tangible Ñxed assets'', the software is capitalized and amortized over its useful life.
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HSBC Finance Corporation
Website design and content development costs are capitalized only to the extent that they lead to thecreation of an enduring asset delivering beneÑts at least as great as the amount capitalized.
Ó U.S. GAAP Ó The American Institute of CertiÑed Public Accountants' (""AICPA'') Statement ofPosition 98-1, ""Accounting for the costs of computer software developed or obtained for internaluse,'' requires that all costs incurred in the preliminary project and post implementation stages ofinternal software development be expensed. Costs incurred in the application development stagemust be capitalized and amortized over their estimated useful life. Website design costs arecapitalized and website content development costs are expensed as they are incurred.
Goodwill
U.K. GAAP‚ Goodwill arising on acquisitions of subsidiary undertakings, associates or joint ventures prior to 1998
was charged against reserves in the year of acquisition.‚ For acquisitions made on or after January 1, 1998, goodwill is included in the balance sheet and
amortized over its estimated useful life on a straight-line basis. U.K. GAAP allows goodwill previouslyeliminated against reserves to be reinstated, but does not require it. In common with many otherU.K. companies, HSBC elected not to reinstate such goodwill on the grounds that it would notmaterially assist the understanding of readers of its accounts who were already familiar withU.K. GAAP.
‚ Goodwill included in the balance sheet is tested for impairment when necessary by comparing therecoverable amount of an entity with the carrying value of its net assets, including attributablegoodwill. The recoverable amount of an entity is the higher of its value in use, generally the presentvalue of the expected future cash Öows from the entity, and its net realizable value.
‚ At the date of disposal of subsidiaries, associates or joint ventures, any unamortized goodwill orgoodwill charged directly against reserves is included in our share of the undertakings' total net assetsin the calculation of the gain or loss on disposal.
‚ Where quoted securities are issued as part of the purchase consideration in an acquisition, the fairvalue of those securities for the purpose of determining the cost of acquisition is the market price at thedate of completion.
U.S. GAAP‚ Goodwill acquired up to June 30, 2001 was capitalized and amortized over its useful life but not more
than 25 years. The amortization of previously acquired goodwill ceased from December 31, 2001.‚ SFAS 142, ""Goodwill and Other Intangible Assets'' requires that goodwill should not be amortized but
should be tested for impairment annually at the reporting unit level by applying a fair-value-based test.‚ The goodwill of a reporting unit should be tested for impairment between annual tests in response to
events or changes in circumstance which could result in an impairment.‚ Where quoted securities are issued as part of the purchase consideration in an acquisition, the fair
value of those securities for the purpose of determining the cost of acquisition is the average marketprice of the securities for a reasonable period before and after the date that the terms of the acquisitionare agreed and announced.
The European Union (""EU'') has determined that all European listed companies will be required to preparetheir consolidated Ñnancial statements using International Financial Reporting Standards (""IFRS GAAP'')by 2005. As a result, HSBC will be required to report their Ñnancial results under IFRS GAAP rather thanU.K. GAAP beginning January 1, 2005. Therefore, beginning in the Ñrst quarter of 2005, we will replace ourreconciliation of U.S. GAAP net income to both U.K. GAAP earnings excluding goodwill amortization andU.K. GAAP net income with a reconciliation of our U.S. GAAP net income to IFRS GAAP net income.
Quantitative Reconciliations of Non-GAAP Financial Measures to GAAP Financial Measures For a reconcil-iation of managed basis net interest income, fee income and provision for credit losses to the comparableowned basis amounts, see ""Segment Results Ó Managed Basis'' in this MD&A. For a reconciliation of our
33
HSBC Finance Corporation
owned loan portfolio by product to our managed loan portfolio, see Note 7, ""Receivables,'' to theaccompanying consolidated Ñnancial statements. For additional quantitative reconciliations of non-GAAPÑnancial measures presented herein to the equivalent GAAP basis Ñnancial measures, see ""Reconciliations toGAAP Financial Measures.''
Critical Accounting Policies
Our consolidated Ñnancial statements are prepared in accordance with accounting principles generallyaccepted in the United States. We believe our policies are appropriate and fairly present the Ñnancial positionof HSBC Finance Corporation.
The signiÑcant accounting policies used in the preparation of our Ñnancial statements are more fully describedin Note 2 to the accompanying consolidated Ñnancial statements. Certain critical accounting policies, whichaÅect the reported amounts of assets, liabilities, revenues and expenses, are complex and involve signiÑcantjudgment by our management, including the use of estimates and assumptions. We recognize the diÅerentinherent loss characteristics in each of our loan products as well as the impact of operational policies such ascustomer account management policies and practices and risk management/collection practices. As a result,changes in estimates, assumptions or operational policies could signiÑcantly aÅect our Ñnancial position or ourresults of operations. We base and establish our accounting estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilities. Actual results may diÅer fromthese estimates under diÅerent assumptions, customer account management policies and practices, riskmanagement/collection practices, or conditions as discussed below.
We believe that of the signiÑcant accounting policies used in the preparation of our consolidated Ñnancialstatements, the items discussed below involve critical accounting estimates and a high degree of judgment andcomplexity. Our management has discussed the development and selection of these critical accounting policieswith the audit committee of our Board of Directors, including the underlying estimates and assumptions, andthe audit committee has reviewed our disclosure relating to these accounting policies and practices in thisMD&A.
Credit Loss Reserves Because we lend money to others, we are exposed to the risk that borrowers may notrepay amounts owed to us when they become contractually due. Consequently, we maintain credit lossreserves at a level that we consider adequate, but not excessive, to cover our estimate of probable losses ofprincipal, interest and fees, including late, overlimit and annual fees, in the existing owned portfolio. Lossreserve estimates are reviewed periodically, and adjustments are reÖected through the provision for creditlosses in the period when they become known. We believe the accounting estimate relating to the reserve forcredit losses is a ""critical accounting estimate'' for the following reasons:
‚ The provision for credit losses totaled $4.3 billion in 2004, $4.0 billion in 2003 and $3.7 billion in 2002and changes in the provision can materially aÅect net income. As a percentage of average ownedreceivables, the provision was 4.28 percent in 2004 compared to 4.45 percent in 2003 and 4.52 percentin 2002.
‚ Estimates related to the reserve for credit losses require us to consider future delinquency and charge-oÅ trends which are uncertain and require a high degree of judgment.
‚ The reserve for credit losses is inÖuenced by factors outside of our control such as customer paymentpatterns, economic conditions, bankruptcy trends and laws.
Because our loss reserve estimate involves judgment and is inÖuenced by factors outside of our control, it isreasonably possible such estimates could change. Our estimate of probable net credit losses is inherentlyuncertain because it is highly sensitive to changes in economic conditions which inÖuence growth, portfolioseasoning, bankruptcy trends, delinquency rates and the Öow of loans through the various stages ofdelinquency, or buckets, the realizable value of any collateral and actual loss exposure. Changes in such
34
HSBC Finance Corporation
estimates could signiÑcantly impact our credit loss reserves and our provision for credit losses. For example, a10% change in our projection of probable net credit losses on owned receivables could have resulted in achange of approximately $400 million in our credit loss reserve for owned receivables at December 31, 2004.The reserve for credit losses is a critical accounting estimate for all three of our reportable segments.
Credit loss reserves are based on a range of estimates and are intended to be adequate but not excessive. Weestimate probable losses for owned consumer receivables using a roll rate migration analysis that estimates thelikelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimatelycharge oÅ. This analysis considers delinquency status, loss experience and severity and takes into accountwhether loans are in bankruptcy, have been restructured or rewritten, or are subject to forbearance, an externaldebt management plan, hardship, modiÑcation, extension or deferment. In addition, our loss reserves onconsumer receivables are maintained to reÖect our judgment of portfolio risk factors that may not be fullyreÖected in the statistical roll rate calculation. Risk factors considered in establishing loss reserves onconsumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations,economic conditions, portfolio seasoning, account management policies and practices and current levels ofcharge-oÅs and delinquencies.
While our credit loss reserves are available to absorb losses in the entire portfolio, we speciÑcally consider thecredit quality and other risk factors for each of our products. We recognize the diÅerent inherent losscharacteristics in each of our products as well as customer account management policies and practices and riskmanagement/collection practices. Charge-oÅ policies are also considered when establishing loss reserverequirements to ensure the appropriate reserves exist for products with longer charge-oÅ periods. We alsoconsider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-oÅs indeveloping our loss reserve estimate.
We periodically re-evaluate our estimate of probable losses for consumer receivables. Changes in our estimateare recognized in our statement of income as provision for credit losses in the period that the estimate ischanged. Our credit loss reserves for owned receivables decreased $168 million to $3.6 billion at December 31,2004 as a direct result of the release of $505 million in December 2004 of credit loss reserves associated withthe bulk sale of our domestic private label receivables to HSBC Bank USA. Excluding the bulk sale, creditloss reserves would have increased at December 31, 2004 reÖecting growth in our loan portfolio, includinglower securitization levels, partially oÅset by improved asset quality. Our reserves as a percentage ofreceivables were 3.40 percent at December 31, 2004, 4.11 percent at December 31, 2003 and 4.04 percent atDecember 31, 2002. Reserves as a percentage of receivables at December 31, 2004 were lower than atDecember 31, 2003 as a result of improved credit quality and higher levels of real estate secured receivables.Compared to December 31, 2002, our reserves as a percentage of receivables at December 31, 2003 increasedas a result of the sale of $2.8 billion of higher quality real estate secured loans to HSBC Bank USA inDecember 2003. Had this sale not occurred, reserves as a percentage of receivables at December 31, 2003would have been lower than 2002 as a result of improving credit quality in the latter half of 2003 asdelinquency rates stabilized and charge-oÅ levels improved.
For more information about our charge-oÅ and customer account management policies and practices, see""Credit Quality Ó Delinquency and Charge-oÅs'' and ""Credit Quality Ó Customer Account ManagementPolicies and Practices.''
Receivables Sold and Serviced With Limited Recourse and Securitization Revenue We have historically used avariety of sources to fund our operations. These sources include the use of collateralized funding transactionswhich are either structured as securitizations, which receive sale treatment, or as secured Ñnancings, which donot receive sale treatment. For securitizations which qualify as sales, the receivables are removed from thebalance sheet and a gain on sale and interest-only strip receivable are recognized. Determination of both thegain on sale and the interest-only strip receivable include estimates of future cash Öows to be received over the
35
HSBC Finance Corporation
lives of the sold receivables. We believe the accounting estimates relating to gains on sale and the value of theinterest-only strip receivable are ""critical accounting estimates'' for the following reasons:
‚ Changes in the estimates of future cash Öows used to determine gains on sale and the value of interest-only strip receivables may materially aÅect net income.
‚ The value of our interest-only strip receivable totaled $323 million at December 31, 2004 and$1,036 million at December 31, 2003. This value may be inÖuenced by factors outside of our controlsuch as customer payment patterns and economic conditions which impact charge-oÅ and delinquency.
‚ Estimates relating to the gain on sale and the value of our interest-only strip receivable require us toforecast cash Öows which are uncertain and require a high degree of judgment.
The lives of the receivables that we securitize and that qualify as sales, are relatively short. Recording gains onsales for receivables with shorter lives reduces the period of time for which cash Öows must be forecasted and,therefore, reduces the potential volatility of these projections. Because our securitization accounting involvesjudgment and is inÖuenced by factors outside of our control, it is reasonably possible such forecasts andestimates could change. Changes in such estimates or in the level or mix of receivables securitized couldsigniÑcantly impact the gains on sale we record and the value of our interest-only strip receivables.Determination of both the gain on sale and the interest-only strip receivable are critical accounting estimatesfor all three of our reportable segments.
We have not structured any real estate secured receivable securitization transactions to receive sale treatmentsince 1997. As a result, the real estate secured receivables, which generally have longer lives than our otherreceivables, and related debt remain on our balance sheet. In the third quarter of 2004, we decided to structureall new collateralized funding transactions as secured Ñnancings. However, because existing public Master-Card/Visa transactions were structured as sales to revolving trusts that require replenishments of receivablesto support previously issued securities, receivables will continue to be sold to these trusts until the revolvingperiods end, the last of which is expected to occur in early 2008 based on current projections. Private labeltrusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of the daily saleof new domestic private label credit card originations to HSBC Bank USA. We will continue to replenish, atreduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued toconduits and record the resulting replenishment gains for a period of time in order to manage liquidity. See""OÅ Balance Sheet Arrangements and Secured Financings'' for further discussion of our decision to fund allnew collateralized funding transactions as secured Ñnancings.
A gain on sale is recognized for the diÅerence between the carrying value of the receivables securitized and theadjusted sales proceeds. The adjusted sales proceeds include cash received and the present value estimate offuture cash Öows to be received over the lives of the sold receivables. Future cash Öows are based on estimatesof prepayments, the impact of interest rate movements on yields of receivables and securities issued,delinquency of receivables sold, servicing fees and estimated probable losses under the recourse provisionsbased on historical experience and estimates of expected future performance. Gains on sale net of recourseprovisions, servicing income and excess spreads relating to securitized receivables are reported as securitiza-tion revenue in our consolidated statements of income.
Securitizations structured as sales transactions also involve the recording of an interest-only receivable whichrepresents our contractual right to receive interest and other cash Öows from the securitization trust. Ourinterest-only strip receivables are reported at fair value using discounted cash Öow estimates as a separatecomponent of receivables, net of our estimate of probable losses under the recourse provisions. Cash Öowestimates include estimates of prepayments, the impact of interest rate movements on yields of receivables andsecurities issued, delinquency of receivables sold, servicing fees and estimated probable losses under therecourse provisions. Unrealized gains and losses are recorded as adjustments to common shareholder's(s')equity in accumulated other comprehensive income, net of income taxes. Our interest-only strip receivablesare reviewed for impairment quarterly or earlier if events indicate that the carrying value may not berecovered. Any decline in the value of our interest-only strip receivable which is deemed to be other thantemporary is charged against current earnings.
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HSBC Finance Corporation
Assumptions used in estimating gains on sales of receivables are evaluated with each securitizationtransaction. Assumptions used in valuing interest-only strip receivables are re-evaluated each quarter based onexperience and expectations of future performances. During 2004 and 2003, we experienced lower interestrates on both the receivables sold and securities issued. In 2004, we generally experienced lower delinquencyand charge-oÅs on the underlying receivables sold but in 2003 we generally experienced higher delinquencyand charge-oÅ on the underlying receivables sold. We also had lower initial securitization of receivables in2004 and in 2003 as a result of the use of alternative funding sources including HSBC subsidiaries and clientsand in 2004, as a result of the decision to structure all new collateralized funding transactions as securedÑnancings as discussed above. These factors impact both the gains recorded and the values of our interest-onlystrip receivables. Securitization gains will vary each year based on the level and rate of receivables securitizedin that particular year. The sensitivity of our interest-only strip receivable to various adverse changes inassumptions and the amount of gain recorded and initial receivables securitized in each period is disclosed inNote 9, ""Asset Securitizations,'' to the accompanying consolidated Ñnancial statements.
Due to our decision to structure all new collateralized funding as secured Ñnancings, securitizationtransactions should continue to decrease in 2005 while secured Ñnancings in 2005 should increase over the2004 levels.
Goodwill and Intangible Assets Goodwill and intangible assets with inÑnite lives are not subject toamortization. Intangible assets with Ñnite lives are amortized over their estimated useful lives. Goodwill andintangible assets are reviewed annually on July 1 for impairment using discounted cash Öows, but impairmentmay be reviewed earlier if circumstances indicate that the carrying amount may not be recoverable. Weconsider signiÑcant and long-term changes in industry and economic conditions to be our primary indicator ofpotential impairment.
We believe the impairment testing of our goodwill and intangibles is a critical accounting estimate due to thelevel of goodwill ($6.9 billion) and intangible assets ($2.7 billion) recorded at December 31, 2004 and thesigniÑcant judgment required in the use of discounted cash Öow models to determine fair value. Discountedcash Öow models include such variables as revenue growth rates, expense trends, interest rates and terminalvalues. Based on an evaluation of key data and market factors, management's judgment is required to selectthe speciÑc variables to be incorporated into the models. Additionally, the estimated fair value can besigniÑcantly impacted by the cost of capital used to discount future cash Öows. The cost of capital percentageis generally derived from an appropriate capital asset pricing model, which itself depends on a number ofÑnancial and economic variables which are established on the basis of management's judgment. Whenmanagement's judgment is that the anticipated cash Öows have decreased and/or the cost of capital hasincreased, the eÅect will be a lower estimate of fair value. If the fair value is determined to be lower than thecarrying value, an impairment charge will be recorded and net income will be negatively impacted.
Impairment testing of goodwill requires that the fair value of each reporting unit be compared to its carryingamount. A reporting unit is deÑned as any distinct, separately identiÑable component of an operating segmentfor which complete, discrete Ñnancial information is available that management regularly reviews. Forpurposes of the annual goodwill impairment test, we assigned our goodwill to our reporting units. At July 1,2004, the estimated fair value of each reporting unit exceeded its carrying value, resulting in none of ourgoodwill being impaired.
Impairment testing of intangible assets requires that the fair value of the asset be compared to its carryingamount. At July 1, 2004, the estimated fair value of each intangible asset exceeded its carrying value and, assuch, none of our intangible assets were impaired.
Contingent Liabilities Both we and certain of our subsidiaries are parties to various legal proceedingsresulting from ordinary business activities relating to our current and/or former operations which aÅect allthree of our reportable segments. Certain of these activities are or purport to be class actions seeking damagesin signiÑcant amounts. These actions include assertions concerning violations of laws and/or unfair treatmentof consumers.
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HSBC Finance Corporation
Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail ineach instance. Also, as the ultimate resolution of these proceedings is inÖuenced by factors that are outside ofour control, it is reasonably possible our estimated liability under these proceedings may change. However,based upon our current knowledge, our defenses to these actions have merit and any adverse decision shouldnot materially aÅect our consolidated Ñnancial condition, results of operations or cash Öows.
Receivables Review
The following table summarizes owned receivables at December 31, 2004 and increases (decreases) over priorperiods:
Total owned receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $106,855 $14,477 16% $24,293 29%
Real estate secured receivables Driven by growth in our correspondent and branch businesses, real estatesecured receivables increased over the year-ago period. Real estate secured receivable levels reÖect sales toHSBC Bank USA of $.9 billion on March 31, 2004 and $2.8 billion on December 31, 2003, as well as HSBCBank USA's purchase of receivables directly from correspondents totaling $2.8 billion in 2004, a portion ofwhich we otherwise would have purchased. Growth in real estate secured receivables was also supplementedby purchases from a single correspondent relationship which totaled $2.6 billion in 2004. Real estate securedreceivable levels in our branch-based consumer lending business improved because of higher sales volumesthan the prior year as we continue to emphasize real estate secured loans, including a near-prime mortgageproduct we Ñrst introduced in 2003. Also contributing to the increase was $900 million of acquisitions from aportfolio acquisition program. The increases in the real estate secured receivable levels have been partiallyoÅset by run-oÅ of higher yielding real estate secured receivables, including second lien loans, largely due toreÑnance activity.
Auto Ñnance receivables Auto Ñnance receivables increased over the year-ago period due to newly originatedloans acquired from our dealer network, strategic alliances established during 2003, increased originationsfrom direct mail solicitations, the Internet and lower securitization levels. This growth was partially oÅset bythe continued liquidation of previously acquired portfolios.
MasterCard and Visa receivables MasterCard and Visa receivables reÖect organic growth especially in oursubprime and Household Bank prime portfolios as well as strong growth in the U.K. Lower securitizationlevels also contributed to the increase at December 31, 2004.
Private label receivables The signiÑcant decrease in private label receivables reÖects the sale of $12.2 billionof domestic private label receivables to HSBC Bank USA in December 2004. Prior to the sale of the domesticprivate label portfolio, private label receivables were higher than the prior year balance by approximately$3.0 billion due to lower securitization levels, a $.5 billion portfolio acquisition and organic growth throughexisting merchants.
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HSBC Finance Corporation
Personal non-credit card receivables Personal non-credit card receivables are comprised of the following:
Union Plus personal non-credit cardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 474 714 1,095
Personal homeowner loans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,693 3,302 4,144
Foreign personal non-credit cardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,080 3,208 2,285
Total personal non-credit cardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $16,128 $12,832 $13,971
Personal non-credit card receivables increased during 2004 as a result of lower securitization levels andincreased marketing. In the second half of 2004, we began to increase the availability of this product as a resultof the improving U.S. economy. In 2003, we intentionally decreased the size of this portfolio throughtightened underwriting and decreased marketing in our branches.
Domestic and foreign personal non-credit card loans (cash loans with no security) are made to customers whomay not qualify for either a real estate secured or personal homeowner loan (""PHL''). The average personalnon-credit card loan is approximately $6,500 and 60 percent of the personal non-credit card portfolio is closed-end with terms ranging from 12 to 60 months. The Union Plus personal non-credit card loans are part of ouraÇnity relationship with the AFL-CIO and are underwritten similar to other personal non-credit card loans.
PHL's typically have terms of 120 to 240 months and are subordinate lien, home equity loans with high(100 percent or more) combined loan-to-value ratios which we underwrite, price and manage like unsecuredloans. The average PHL is approximately $19,000. Because recovery upon foreclosure is unlikely aftersatisfying senior liens and paying the expenses of foreclosure, we do not consider the collateral as a source forrepayment in our underwriting. Historically, these loans have performed better from a credit loss perspectivethan traditional unsecured loans as consumers are more likely to pay secured loans than unsecured loans intimes of Ñnancial distress.
Distribution and Sales We reach our customers through many diÅerent distribution channels and our growthstrategies vary across product lines. The consumer lending business originates real estate and personal non-credit card products through its retail branch network, direct mail, telemarketing, strategic alliances andInternet applications. The mortgage services business originates real estate secured receivables throughbrokers and purchases real estate secured receivables primarily through correspondents. Private labelreceivables are generated through merchant promotions, application displays, Internet applications, direct mailand telemarketing. Auto Ñnance receivables are generated primarily through dealer relationships from whichinstallment contracts are purchased. Additional auto Ñnance receivables are generated through direct lendingwhich includes alliance partner referrals, Internet applications and direct mail. MasterCard and Visareceivables are generated primarily through direct mail, telemarketing, Internet applications, applicationdisplays, promotional activity associated with our co-branding and aÇnity relationships, mass media advertise-ments and merchant relationships sourced through our retail services business. We also supplement internally-generated receivable growth with portfolio acquisitions.
Our acquisition by HSBC has allowed us to enlarge our customer base through cross-selling products toHSBC customers as well as generating new business with various major corporations. The rebranding of themajority of our U.S. and Canadian businesses to the HSBC brand in September 2004 has positively impactedthese eÅorts. A Consumer Finance team has been established to help extend the U.S. business model toemerging markets across the HSBC Group.
Based on certain criteria, we oÅer personal non-credit card customers who meet our current underwritingstandards the opportunity to convert their loans into real estate secured loans. This enables our customers tohave access to additional credit at lower interest rates. This also reduces our potential loss exposure andimproves our portfolio performance as previously unsecured loans become secured. We converted approxi-
39
HSBC Finance Corporation
mately $520 million of personal non-credit card loans into real estate secured loans in 2004 and $350 million in2003. It is not our practice to rewrite or reclassify delinquent secured loans (real estate or auto) into personalnon-credit card loans.
Results of Operations
Unless noted otherwise, the following discusses amounts reported in our owned basis statement of income.
Net interest income The following table summarizes net interest income:
Year ended December 31, 2004 2003 2002
Restated(dollars are in millions)
Finance and other interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $10,945 $10,242 $10,525
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 7,802 $ 7,314 $ 6,654
Net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.33% 7.75% 7.57%
The increase in net interest income during 2004 was due to higher average receivables partially offset by loweryields on our receivables, particularly real estate secured, auto finance and personal non-credit card receivables andhigher interest expense. The lower yields in 2004 reflect strong receivable and refinancing growth which hasoccurred in an economic cycle with historically low market rates, high liquidation of older, higher yielding loans,product expansion into near-prime customer segments and competitive pricing pressures due to excess marketcapacity. All of these factors contributed to a decrease in overall loan yields. The higher interest expenseexperienced in 2004 was due to a larger balance sheet partially offset by a lower cost of funds. Our purchaseaccounting fair value adjustments include both amortization of fair value adjustments to our external debtobligations and receivables. Amortization of purchase accounting fair value adjustments increased net interestincome by $697 million in 2004 and $570 million in 2003.
The increase in net interest income during 2003 was attributable to higher average receivables and lower cost offunds including the amortization of purchase accounting fair value adjustments, partially offset by lower yields onour receivables due to reduced pricing and the amortization of purchase accounting fair value adjustments.
Net interest margin was 7.33 percent in 2004, 7.75 percent in 2003 and 7.57 percent in 2002. As discussed above,lower yields on certain products drove the decrease in 2004, partially offset by lower funding costs on our debt. Theincrease in 2003 was attributable to a lower cost of funds, including the amortization of purchase accounting fairvalue adjustments applied to our external debt obligations, partially offset by lower yields on our receivables,particularly real estate secured, due to reduced pricing and the amortization of purchase accounting fair valueadjustments to our receivables.
Our net interest margin on an owned basis was impacted by the loss of hedge accounting on the hedgingrelationships at the time of merger. The loss of hedge accounting on the impacted hedging relationshipsreduced net interest income by $236 million in 2004 and $307 million in 2003. The following table comparesour reported net interest margin to what it otherwise would have been if hedge accounting had not been lost:
* Represents a non-GAAP Ñnancial measure which is being provided for comparison of our trends and should be read in conjunction with
our reported results.
40
HSBC Finance Corporation
Our net interest income on a managed basis includes Ñnance income earned on our owned receivables as wellas on our securitized receivables. This Ñnance income is oÅset by interest expense on the debt recorded on ourbalance sheet as well as the contractual rate of return on the instruments issued to investors when thereceivables were securitized. Managed basis net interest income was $10.3 billion in 2004, $10.2 billion in2003 and $9.3 billion in 2002. Managed basis net interest margin was 7.97 percent in 2004 compared to8.60 percent in 2003 and 8.47 percent in 2002. The decrease in net interest margin in 2004 was due to loweryields on our receivables, partially oÅset by lower funding costs on our debt as discussed above. Lower fundingcosts and the impact of the previously discussed amortization of purchase accounting adjustments were theprimary drivers of the increase in net interest margin in 2003. Net interest margin is greater than on an ownedbasis because the managed basis portfolio includes more unsecured loans which have higher yields.
Our net interest margin on a managed basis was impacted by the loss of hedge accounting as discussed above.The following table compares our reported net interest margin to what it otherwise would have been had hedgeaccounting not been lost:
* Represents a non-GAAP Ñnancial measure which is being provided for comparison of our trends and should be read in conjunction with
our reported results.
Our interest earning assets expose us to interest rate risk. We try to manage this risk by borrowing money withsimilar interest rate and maturity proÑles; however, there are instances when this cannot be achieved. Whenthe various risks inherent in both the asset and the debt to do not meet our desired risk proÑle, we usederivative Ñnancial instruments to manage these risks to acceptable interest rate risk levels. See ""RiskManagement'' for additional information regarding interest rate risk and derivative Ñnancial instruments.
See the ""Net Interest Margin'' tables and ""Reconciliation to GAAP Financial Measures'' for additionalinformation regarding our owned basis and managed basis net interest income.
Provision for credit losses The provision for credit losses includes current period net credit losses and anamount which we believe is suÇcient to maintain reserves for losses of principal, interest and fees, includinglate, overlimit and annual fees, at a level that reÖects known and inherent losses in the portfolio. Growth inreceivables and portfolio seasoning ultimately result in higher provision for credit losses. The provision forcredit losses may also vary from year to year depending on a variety of additional factors including product mixand the credit quality of the loans in our portfolio, historical delinquency roll rates, customer accountmanagement, risk management/collection policies related to our loan products, economic conditions and ourproduct vintage analysis.
The following table summarizes provision for owned credit losses:
Year ended December 31, 2004 2003 2002
Provision for credit lossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,334 $3,967 $3,732
Our provision for credit losses increased in 2004 compared to 2003. The adoption of FFIEC charge-oÅ policiesfor our domestic private label and MasterCard/Visa portfolios resulted in a $38 million increase to lossprovision in the fourth quarter of 2004 as the incremental charge-oÅ of $158 million associated with theseproducts was partially oÅset by the release of $120 million in existing credit loss reserves. In 2004, we recordedcredit loss provision greater than net charge-oÅs of $301 million. Excluding the impact of the adoption ofFFIEC charge-oÅ policies as previously discussed, credit loss provision was $421 million greater than net
41
HSBC Finance Corporation
charge-oÅs. Our credit loss provision increased in 2004 due to receivable growth, including lower securitizationlevels, partially oÅset by improving asset quality. Net charge-oÅ dollars for 2004 increased $446 million($288 million excluding FFIEC) compared to 2003 as higher delinquencies due to adverse economicconditions which existed in 2003 migrated to charge-oÅ in 2004, which was partially oÅset by an overallimprovement in asset quality during 2004. Owned loss provision was greater than charge-oÅs by $380 millionin 2003 and $603 million in 2002. Receivable growth, increases in personal bankruptcy Ñlings and the weakeconomy contributed to the increase in provision dollars in 2003.
The provision as a percent of average owned receivables was 4.28 percent in 2004, 4.45 percent in 2003 and4.52 percent in 2002. Excluding the impact of adopting FFIEC charge-oÅ policies as described above, theprovision as a percentage of average owned receivables in 2004 would have been lower by 4 basis points. Thedecrease in 2004 reÖects receivable growth and improved credit quality. The decrease in 2003 reÖects loweradditions to loss reserves as a result of improving charge-oÅs in the latter half of 2003.
See ""Critical Accounting Policies,'' ""Credit Quality,'' ""Analysis of Credit Loss Reserves Activity'' and""Reconciliations to GAAP Financial Measures'' for additional information regarding our owned basis andmanaged basis loss reserves and the adoption of FFIEC policies. See Note 8, ""Credit Loss Reserves'' in theaccompanying consolidated Ñnancial statements for additional analysis of the owned basis and managed basisloss reserves.
Other revenues The following table summarizes other revenues:
Derivative income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 511 286 3
Fee income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,091 1,064 948
Taxpayer Ñnancial services income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 217 185 240
Other income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 607 381 301
Gain on bulk sale of private label receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 663 Ó Ó
Loss on disposition of Thrift assets and deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ó Ó (378)
Total other revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,073 $4,319 $4,146
Securitization revenue is the result of the securitization of our receivables and includes the following:
Year ended December 31, 2004 2003 2002
(in millions)
Net initial gains(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 25 $ 176 $ 322
Net replenishment gains(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 414 548 523
Servicing revenue and excess spreadÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 569 737 1,289
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,008 $1,461 $2,134
(1) Net of our estimate of probable credit losses under the recourse provisions
The decrease in securitization revenue in 2004 was due to lower levels and changes in the product mix ofreceivables securitized during the year, including the impact of higher receivables run-oÅ and the shorterexpected lives of securitization trusts as a result of our decision in the third quarter of 2004 to structure all newcollateralized funding transactions as secured Ñnancings. However, because existing public MasterCard andVisa credit card transactions were structured as sales to revolving trusts that require replenishments of
42
HSBC Finance Corporation
receivables to support previously issued securities, receivables will continue to be sold to these trusts until therevolving periods end, the last of which is expected to occur in early 2008 based on current projections. Privatelabel trusts that publicly issued securities will now be replenished by HSBC Bank USA as a result of the dailysales of new domestic private label originations to HSBC Bank USA. We will continue to replenish at reducedlevels, certain non-public personal non-credit card and MasterCard and Visa securities issued to conduits andrecord the resulting replenishment gains for a period of time in order to manage liquidity. Since our securitizedreceivables have varying lives, it will take several years for these receivables to pay-oÅ and the related interest-only strip receivables to be reduced to zero. While the termination of sale treatment on new collateralizedfunding activity and the reduction of sales under replenishment agreements reduced our reported net incomeunder U.S. GAAP, there was no impact on cash received from operations or on U.K. GAAP reported results.
The decrease in securitization revenue in 2003 was due to decreases in the level of initial securitizations duringthe year as a result of the use of alternative funding sources, including funding from HSBC subsidiaries andclients, lower excess spread especially at auto Ñnance due to higher loss estimates as a result of certain vintagesperforming worse than expected and the amortization of purchase accounting fair value adjustments on ourinterest-only strip receivables.
Our interest-only strip receivables, net of the related loss reserve and excluding the mark-to-marketadjustment recorded in accumulated other comprehensive income and, in 2004, the private label portionpurchased by HSBC Bank USA, decreased $466 million in 2004 and $430 million in 2003.
See Note 2, ""Summary of SigniÑcant Accounting Policies,'' and Note 9, ""Asset Securitizations,'' to theaccompanying consolidated Ñnancial statements, and ""Critical Accounting Policies'' and ""OÅ Balance SheetArrangements and Secured Financings'' for further information on asset securitizations.
Insurance revenue increased in 2004 due to increased sales in our U.K. business partially oÅset by slightlylower revenue from our domestic operations due to the continued run oÅ of insurance products discontinued inprior years. The increase in insurance revenue in 2003 was also due to increased sales in our U.K. businesspartially oÅset by decreased sales in our domestic portfolio as a result of decreased originations in our branchesin the Ñrst half of 2003 as well as a general decline in the percentage of customers who purchase insurance.
Investment income, which includes income on securities available for sale in our insurance business andrealized gains and losses from the sale of securities, decreased in 2004 as a result of decreases in income due tolower yields on lower average balances, lower gains from security sales and reduced amortization of purchaseaccounting fair value adjustments. In 2003, higher realized gains on security sales were partially oÅset bylower yields including the impact of the amortization of purchase accounting fair value adjustments.
Derivative income, which includes realized and unrealized gains and losses on derivatives which do not qualifyas eÅective hedges under SFAS 133 as well as the ineÅectiveness on derivatives associated with our qualifyinghedges is summarized in the table below:
2004 2003 2002
(in millions)
Net realized gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 68 $ 54 $ Ó
Net unrealized gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 442 230 Ó
Derivative income increased in 2004 due to an increasing interest rate environment and a weakening of theU.S. dollar which caused our currency swaps and pay Ñxed interest rate swaps, which do not qualify for hedgeaccounting under SFAS 133, to increase in value. These derivatives remain economic hedges of the underlyingdebt instruments. The increase in derivative income in 2003 reÖects the loss of hedge accounting for all pre-existing hedging relationships following our acquisition by HSBC, including those that had previously qualiÑedfor shortcut accounting under SFAS 133 prior to the merger.
43
HSBC Finance Corporation
Fee income, which includes revenues from fee-based products such as credit cards, increased in 2004 and 2003due to higher credit card fees, particularly relating to our subprime credit card portfolio. For 2004, the highercredit card fees were partially oÅset by higher payments to merchant partners as a result of portfolioacquisitions in our retail services business. See Note 23, ""Business Segments,'' to the accompanyingconsolidated Ñnancial statements for additional information on fee income on a managed basis.
Taxpayer Ñnancial services (""TFS'') income increased in 2004 primarily due to lower funding costs as a resultof our acquisition by HSBC. The decrease in TFS income in 2003 was a result of higher funding costs,participation payments and credit losses.
Other income increased in 2004 and 2003. The increase in 2004 was due to higher ancillary credit cardrevenue, higher income associated with aÇliate transactions and higher gains on miscellaneous asset sales,including the partial sale of a real estate investment. In 2003, the increase was due to higher loan sale revenuefrom our mortgage operations.
Gain on bulk sale of private label receivables resulted from the sale of $12.2 billion of domestic private labelreceivables ($15.6 billion on a managed basis) including the retained interests associated with securitizedprivate label receivables to HSBC Bank USA in December 2004. See Note 5, ""Sale of Domestic PrivateLabel Receivable Portfolio and Adoption of FFIEC Policies,'' to the accompanying consolidated Ñnancialstatements for further information.
Loss on disposition of Thrift assets and deposits resulted from the disposition of substantially all of theremaining assets and deposits of the Thrift in the fourth quarter of 2002.
Costs and Expenses EÅective January 1, 2004, our technology services employees were transferred to HSBCTechnology and Services (USA) Inc. (""HTSU''). As a result, operating expenses relating to informationtechnology as well as certain item processing and statement processing activities, which have previously beenreported as salaries and fringe beneÑts, occupancy and equipment expenses, or other servicing and administra-tive expenses, are now billed to us by HTSU and reported as support services from HSBC aÇliates. Supportservices from HSBC aÇliates also include banking services and other miscellaneous services provided byHSBC Bank USA and other subsidiaries of HSBC.
The following table summarizes total costs and expenses:
Year ended December 31, 2004 2003 2002
(in millions)
Salaries and employee beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,886 $1,998 $1,817
Settlement charge and related expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 525
HSBC acquisition related costs incurred by HSBC Finance Corporation ÏÏÏÏÏ - 198 -
Total costs and expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,601 $5,191 $4,815
Salaries and employee beneÑts decreased in 2004 primarily due to the transfer of our technology personnel toHTSU. Excluding this change, salaries and fringe beneÑts increased $126 million in 2004 as a result ofadditional staÇng to support growth, primarily in our consumer lending, mortgage services and international
44
HSBC Finance Corporation
business units and in our compliance functions. In addition to the above, higher employee beneÑt planexpenses also contributed to the increase in 2003.
Sales incentives increased in 2004 due to higher volumes in our branches and increases in our mortgageservices business. The increase in 2003 was primarily due to increases in our mortgage services business,partially oÅset by lower new loan volume in our branches and our auto Ñnance business.
Occupancy and equipment expenses decreased in 2004 primarily due to the formation of HTSU as discussedabove. The increase in 2003 was primarily the result of higher repairs and occupancy maintenance costs.
Other marketing expenses includes payments for advertising, direct mail programs and other marketingexpenditures. The increase in 2004 was primarily due to increased credit card marketing, largely due tochanges in contractual marketing responsibilities associated with the General Motors (""GM'') co-brandedcredit card. These changes will result in higher marketing expense for the GM Card» in the future. Theincrease in 2003 was primarily due to increased marketing initiatives in our domestic MasterCard and Visaportfolios.
Other servicing and administrative expenses decreased in 2004 primarily due to the transfer of certain itemprocessing and statement processing services to HTSU. This decrease was partially oÅset by higher systemsand credit bureau costs due to growth, higher insurance commissions and costs associated with the rebranding.Higher collection, legal, compliance and REO expenses as well as receivable growth contributed to theincrease in 2003.
Support services from HSBC aÇliates primarily include technology and other services charged to us by HTSUsince its inception on January 1, 2004.
Amortization of intangibles increased in 2004 and 2003 due to the higher amortization of intangiblesestablished in conjunction with the HSBC merger on March 28, 2003. Due to the timing of the merger, therewere nine months of amortization expense in 2003 compared with a full year of amortization expense in 2004.
Policyholders' beneÑts increased in both 2004 and 2003 due to higher sales in our U.K. business and higheramortization of fair value adjustments relating to our insurance business, partially oÅset by lower expenses inour domestic business.
HSBC acquisition related costs incurred by HSBC Finance Corporation in the Ñrst quarter of 2003 includepayments to executives under existing employment contracts and investment banking, legal and other costsrelating to our acquisition by HSBC.
The following table summarizes our owned basis eÇciency ratio:
Year ended December 31, 2004 2003 2002
Restated
GAAP basis eÇciency ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 41.6% 42.8% 42.6%
(1) Represents a non-GAAP Ñnancial measure. See ""Basis of Reporting'' for additional discussion on the use of this non-GAAP Ñnancial
measure and ""Reconciliations to GAAP Financial Measures'' for quantitative reconciliations of our operating eÇciency ratio to our
owned basis GAAP eÇciency ratio.
The deterioration in the eÇciency ratio on an operating basis for 2004 was primarily attributable to an increasein operating expenses, including higher intangible amortization, lower securitization revenue and lower overallyields on our receivables partially oÅset by higher derivative income. The deterioration in the eÇciency ratioon an operating basis in 2003 reÖects lower securitization revenue and higher operating expenses, partiallyoÅset by higher net interest income and higher derivative income.
45
HSBC Finance Corporation
Income taxes Our eÅective tax rates were as follows:
Year ended December 31, 2004 (successor)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 34.0%
March 29 through December 31, 2003 (successor) (Restated) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33.7
January 1 through March 28, 2003 (predecessor) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42.5
Year ended December 31, 2002 (predecessor) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30.9
The eÅective tax rate for January 1 through March 28, 2003 was adversely impacted by the non-deductibilityof certain HSBC acquisition related costs. The lower eÅective tax rate in 2002 was largely attributable to lowerstate and local taxes and a reduction in noncurrent tax requirements.
Segment Results Ó Managed Basis
We have three reportable segments: Consumer, Credit Card Services and International. Our Consumersegment consists of our consumer lending, mortgage services, retail services and auto Ñnance businesses. OurCredit Card Services segment consists of our domestic MasterCard and Visa credit card business. OurInternational segment consists of our foreign operations in the United Kingdom, Canada, the Republic ofIreland, the Czech Republic and Hungary.
EÅective January 1, 2004, our direct lending business, which has previously been reported in our ""All Other''caption, was consolidated into our consumer lending business and as a result is now included in our Consumersegment. Prior periods have not been restated as the impact was not material. There have been no otherchanges in the basis of our segmentation or any changes in the measurement of segment proÑt as comparedwith the presentation in our 2003 Form 10-K.
The accounting policies of the reportable segments are described in Note 2, ""Summary of SigniÑcantAccounting Policies,'' to the accompanying Ñnancial statements. For segment reporting purposes, interseg-ment transactions have not been eliminated. We generally account for transactions between segments as ifthey were with third parties. We evaluate performance and allocate resources based on income fromoperations after income taxes and returns on equity and managed assets.
We provide information to management, monitor our operations and evaluate trends on a managed basis (anon-GAAP Ñnancial measure), which assumes that securitized receivables have not been sold and are still onour balance sheet. We manage and evaluate our operations on a managed basis because the receivables thatwe securitize are subjected to underwriting standards comparable to our owned portfolio, are serviced byoperating personnel without regard to ownership and result in a similar credit loss exposure for us. In addition,we fund our operations, review our operating results, and make decisions about allocating resources such asemployees and capital on a managed basis.
When reporting on a managed basis, net interest income, provision for credit losses and fee income related toreceivables securitized are reclassiÑed from securitization revenue in our owned statement of income into theappropriate caption.
46
HSBC Finance Corporation
Consumer Segment The following table summarizes results for our Consumer segment:
Year ended December 31, 2004 2003 2002
(in millions)
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,563 $ 1,061 $ 838
Operating net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,247 1,061 1,411
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,699 7,333 6,976
Fee and other income, excluding gain on the bulk sale of domestic privatelabel receivables and loss on disposition of Thrift assets and deposits ÏÏÏ 638 664 644
Gain on bulk sale of private label receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 683 - -
Loss on disposition of Thrift assets and depositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 378
Net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8.20% 8.59% 8.68%
Return on average managed assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.64 1.22 1.02
Our Consumer Segment reported higher net income in 2004 and 2003. Operating net income (a non-GAAPÑnancial measure of net income excluding the gain on the bulk sale of the domestic private label portfolio andthe impact of adoption of FFIEC charge-oÅ policies for our domestic private label portfolio in 2004 and thesettlement charge and related expenses and the Thrift disposition loss in 2002) increased in 2004 butdecreased in 2003. In 2004, the increase in operating net income was due to increases in net interest incomeand decreases in provision for credit losses which were partially oÅset by higher operating expenses andsubstantially lower securitization revenue. Net interest income increased primarily due to higher receivablelevels. Net interest margin, however, decreased primarily due to faster growth in lower yielding real estatesecured lending, lower yields on real estate secured, auto Ñnance and personal non-credit card receivables as aresult of competitive pressure on pricing, as well as the run oÅ of higher yielding real estate securedreceivables, including second lien loans largely due to reÑnance activity. Our auto Ñnance businessexperienced lower yields as we have targeted lower yielding but higher credit quality customers. Thesedecreases were partially oÅset by lower cost of funds. Securitization revenue decreased in 2004 as a result of asigniÑcant decline in receivables securitized, including the impact of higher run-oÅ due to shorter expectedlives as a result of our decision to structure all new collateralized funding transactions as secured Ñnancingsbeginning in the third quarter of 2004. Securitization levels were also lower in 2004 as we used funding fromHSBC, including proceeds from sales of receivables, to assist in the funding of our operations. Operatingexpenses increased in 2004 as the result of additional operating costs to support the increased receivable levels,including higher salaries and sales incentives.
As previously discussed, in December 2004, we adopted FFIEC charge-oÅ policies for our domestic privatelabel credit card portfolio which resulted in a reduction to net income of $120 million and subsequently soldthe portfolio to HSBC Bank USA. We recorded a pre-tax gain of $663 million on the sale. See ""CreditQuality'' and Note 5, ""Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIEC Policies,''to the accompanying consolidated Ñnancial statements for further discussion of the adoption of FFIECcharge-oÅ policies and the portfolio sale.
Our managed basis provision for credit losses, which includes both provision for owned receivables andover-the-life provision for receivables serviced with limited recourse, decreased in 2004 as a result of
47
HSBC Finance Corporation
improving credit quality, changes in securitization levels and a corporate adjustment to decrease owned reservelevels. This was modestly oÅset by the impact of adoption of FFIEC charge-oÅ policies which increasedmanaged basis provision $81 million. We experienced higher dollars of net charge-oÅs in our owned portfolioduring 2004. This was in part because of the acceleration of charge-oÅ upon adoption of FFIEC charge-oÅpolicies for our domestic private label portfolio, but also as a result of higher levels of owned receivables andthe higher delinquency levels in 2003 which progressed to charge-oÅ in 2004. Our overall owned provision forcredit losses was $57 million lower than net charge-oÅs as charge-oÅs are a lagging indicator of credit quality.Over-the-life provisions for credit losses for securitized receivables recorded in any given period reÖect thelevel and product mix of securitizations in that period. Subsequent charge-oÅs of such receivables result in adecrease in the over-the-life reserves without any corresponding increase to managed loss provision. Thecombination of these factors, including changes in securitization levels, resulted in an overall decrease inmanaged loss reserves as net charge-oÅs were greater than the provision for credit losses by $1,229 million in2004. In 2003, we increased managed loss reserves by recording provision greater than net charge-oÅs of$768 million.
Compared to operating net income in 2002, the decline in net income in 2003 was due to higher provisions forcredit losses, lower securitization revenue and higher operating expenses, partially oÅset by higher net interestincome and fee and other income. The increase in provision in 2003 was the result of increased levels ofreceivables, higher provision for credit losses on securitized receivables, including higher estimated losses atauto Ñnance, and higher levels of charge-oÅ due, in part, to a weak economy. The decrease in securitizationrevenue in 2003 was due to a signiÑcant decrease in initial securitization volume, primarily in our auto Ñnancebusiness as a result of alternative funding including HSBC subsidiaries and customers. The increase in netinterest income and fee and other income in 2003 was due to the growth in average receivables we experiencedduring the year. Operating expenses (excluding the 2002 attorney general settlement charge and relatedexpenses) increased as a result of additional operating costs to support the receivable growth and higher legaland compliance costs.
Managed receivables increased 1 percent compared to $87.1 billion at December 31, 2003. The rate ofincrease in managed receivables was impacted by the sale of $15.6 billion in domestic private label receivablesto HSBC Bank USA in December of 2004. Had this sale not taken place, managed receivables would haveincreased by $16.3 billion or 19 percent in 2004. We experienced strong growth in 2004 in our real estatesecured receivables in both our correspondent and branch-based consumer lending businesses, which waspartially oÅset by $2.8 billion of correspondent receivables purchased directly by HSBC Bank USA (a portionof which we otherwise would have purchased). Growth in our correspondent business was supplemented bypurchases from a single correspondent relationship which totaled $2.6 billion in 2004. We also experiencedsolid growth in auto Ñnance receivables though our dealer network and increased direct mail solicitations.Personal non-credit card receivables also experienced growth in 2004 as we began to increase availability ofthis product in the second half of the year as a result of an improving economy. Prior to the sale of thedomestic portfolio in December 2004, our private label receivables increased due to organic growth throughexisting merchants and a $.5 billion portfolio acquisition.
Managed receivables increased 10 percent to $87.1 billion at December 31, 2003 compared to $79.4 billion atDecember 31, 2002. The managed receivable growth in 2003 was driven primarily by growth in real estatesecured receivables in our correspondent business. In 2003, our branch-based consumer lending businessreported strong real estate secured originations in the second half of 2003 following weak sales momentum inthe Ñrst half of 2003 as a result of our intentional fourth quarter 2002 slowdown and higher run-oÅ. Real estategrowth in 2003 was impacted by the $2.8 billion loan sale to HSBC Bank USA to utilize HSBC liquidity. Ourprivate label portfolio also reported strong growth in 2003 as a result of portfolio acquisitions as well as organicgrowth.
Return of average managed assets (""ROMA'') was 1.64 percent in 2004, 1.22 percent in 2003 and1.02 percent in 2002. The increase in the ratio reÖects higher levels of net income. On an operating basis,ROMA was 1.32 percent in 2004, 1.22 percent in 2003 and 1.71 percent in 2002. The increase in ROMA on
48
HSBC Finance Corporation
an operating basis in 2004 reÖects the higher operating net income as discussed above. The decline in ROMAon an operating basis in 2003 reÖects lower securitization revenue and higher provision for credit losses andoperating expenses.
Credit Card Services Segment The following table summarizes results for our Credit Card Services segment.
Year ended December 31, 2004 2003 2002
(in millions)
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 380 $ 500 $ 414
Operating net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 381 500 414
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,070 1,954 1,768
Net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10.00% 9.87% 9.84%
Return on average managed assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.82 2.44 2.20
Our Credit Card Services segment reported lower net income and operating net income (a non-GAAPÑnancial measure of net income excluding the impact of adopting FFIEC charge-oÅ policies) in 2004. Thedecrease in net income was due to lower securitization levels and higher operating expenses, particularlymarketing expenses, partially oÅset by increases in net interest income as well as fee and other income.Increases in net interest income as well as fee and other income in 2004 resulted from higher subprimereceivable levels. Net interest margin increased compared to 2003 due to higher subprime receivable levelsand lower funding costs. Although our subprime receivables tend to have smaller balances, they generatehigher returns both in terms of net interest margin and fee income. Securitization revenue declined as a resultof a decline in receivables securitized, including higher run-oÅ due to shorter expected lives. Our provision forcredit losses was Öat in 2004 as reductions due to improving credit quality and changes in securitization levelswere oÅset by higher levels of subprime receivables which carry a higher reserve requirement and a corporateadjustment to increase owned reserve levels. We increased managed loss reserves by recording loss provisiongreater than net charge-oÅ of $123 million in 2004.
Our Credit Card Segment reported higher net income in 2003 compared to 2002. The increase was dueprimarily to higher net interest income and fee and other income, partially oÅset by higher provision for creditlosses and lower securitization revenue. The higher provision for credit losses was due to increased receivablelevels as well as the continued weak economy that was experienced in 2003. We increased managed lossreserves by recording loss provision greater than charge-oÅs of $153 million in 2003. Growth in receivablesdrove the increase in both net interest income and fee and other income in 2003 The decrease in securitizationrevenue in 2003 was also due to a decline in initial securitization volume in 2003.
As previously discussed, in December 2004, we adopted FFIEC charge-oÅ policies for the remainder of ourdomestic MasterCard and Visa portfolio, which resulted in an immaterial reduction to net income. See""Credit Quality'' for further discussion of the FFIEC policies and the impact of their adoption.
Managed receivables of $19.7 billion at December 31, 2004 were Öat compared to $19.6 billion atDecember 31, 2003. In 2004, increases in our AFL-CIO Union Plus portfolios, subprime and prime portfolioswere substantially oÅset by the continued decline in certain older acquired portfolios. Receivable growth in2003 reÖects strong growth in our GM portfolio, portfolio acquisitions totaling $.9 billion and organic growthin our subprime and AFL-CIO Union Plus portfolios.
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HSBC Finance Corporation
ROMA decreased in 2004 compared to 2003 reÖecting the lower net income as discussed above. Theimprovement in ROMA in 2003 compared to 2002 reÖects higher net interest margin and fee income, partiallyoÅset by higher provision for credit losses.
International Segment The following table summarizes results for our International segment:
Year ended December 31, 2004 2003 2002
(in millions)
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 95 $ 170 $ 231
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 797 753 641
Net interest marginÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.69% 7.44% 8.06%
Return on average managed assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .76 1.57 2.60
Our International segment reported lower net income in 2004 and 2003. In both years, the decrease in netincome reÖects higher operating expenses and lower securitization revenue partially oÅset by increased fee andother income, and higher net interest income. Net income in 2004 also reÖects lower provision for creditlosses. However, provision for credit losses increased in 2003. Applying constant currency rates, which uses theaverage rate of exchange for the 2003 period to translate current period net income, net income would havebeen lower by $6 million in 2004. Applying constant currency rates for the 2002 period to translate 2003income, net income for 2003 would have been lower by $18 million.
Net interest income increased in 2004 and 2003 due to higher receivable levels, partially oÅset by a slightlyhigher cost of funds in 2004. Net interest margin decreased in 2004 and 2003 due to run oÅ of higher yieldingreceivables, competitive pricing pressures on our personal loans in the U.K. and a higher cost of funds. In2004, this was partially oÅset by increased yields on credit cards as interest-free balances were not promoted asstrongly as in the past. Securitization revenue also declined in 2004 and 2003 as a result of lower levels ofsecuritized receivables. Fee and other income increased in both years primarily due to higher insurancerevenues. Provision for credit losses decreased in 2004 due to changes in securitization levels, partially oÅsetby a higher provision for credit losses on owned receivables due to receivable growth and higher delinquencyand charge-oÅ levels in the U.K. We decreased managed loss reserves in 2004 by recording loss provision lessthan net charge-oÅs of $29 million. We increased managed loss reserves in 2003 by recording loss provisiongreater than charge-oÅs of $69 million due to receivable growth. Total costs and expenses increased in 2004and 2003 primarily due to higher salary expenses to support receivable growth, including the full year impactin 2004 of operating costs associated with a 2003 private label portfolio acquisition, and higher policyholderbeneÑts because of increased insurance sales volumes. The increase in costs and expenses in 2003 also reÖectsadditional cost associated with a 2003 private label portfolio acquisition.
Managed receivables of $13.3 billion at December 31, 2004 increased 20.5 percent compared to $11.0 billionat December 31, 2003. The increase during 2004 was due to strong growth in real estate secured andMasterCard/Visa as well as growth from the introduction of auto Ñnance receivables in Canada. Receivablegrowth in both years reÖects positive foreign exchange translation impacts of $1.0 billion at December 31,2004 compared to December 31, 2003 foreign exchange rates and $1.2 billion at December 31, 2003 comparedto December 31, 2002 foreign exchange rates. Additionally in 2003, all products reported growth, including a$.4 billion private label portfolio acquisition in the U.K. in the second quarter of 2003.
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HSBC Finance Corporation
The decrease in ROMA for 2004 and 2003 reÖects the lower net income as discussed above.
Reconciliation of Managed Basis Segment Results As discussed above, we monitor our operations on amanaged basis. Therefore, an adjustment is required to reconcile the managed Ñnancial information to ourreported Ñnancial information in our consolidated Ñnancial statements. This adjustment reclassiÑes netinterest income, fee income and loss provision into securitization revenue. See Note 23, ""Business Segments,''in the accompanying consolidated Ñnancial statements for a reconciliation of our managed basis segmentresults to managed basis and owned basis consolidated totals.
Credit Quality
Adoption of FFIEC Charge-oÅ and Account Management Policies Upon receipt of regulatory approval forthe sale of our domestic private label portfolio to HSBC Bank USA in December 2004, we adopted charge-oÅand account management guidelines in accordance with the Uniform Retail Credit ClassiÑcation and AccountManagement Policy issued by the Federal Financial Institutions Examination Council for our domestic privatelabel and our MasterCard and Visa portfolios.
FFIEC policies require that private label and MasterCard/Visa credit card accounts be charged-oÅ no laterthan the end of the month in which the account becomes 180 days delinquent. For accounts involving abankruptcy, charge-oÅ should occur by the end of the month 60 days after notiÑcation or 180 days delinquent,whichever is sooner. Certain domestic MasterCard and Visa portfolios were following FFIEC charge-oÅpolicies prior to December 2004. Domestic private label receivables originated through new merchantrelationships after October 2002, which represented 18.8 percent of the portfolio at the sale date, were alsofollowing the 180-day charge-oÅ policy. The remainder of our domestic private label credit card receivableportfolio previously charged-oÅ receivables the month following the month in which the account became9 months contractually delinquent. Prior to the adoption of the FFIEC charge-oÅ policies, our private labelcredit card portfolio recorded charge-oÅ involving a bankruptcy by the end of the month 90 days afterbankruptcy notiÑcation was received.
The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa receivablesresulted in a reduction to our net income of approximately $121 million as summarized below:
Private MasterCardLabel and Visa
Portfolio Portfolio Total
(in millions)
Net interest income:Reversal of Ñnance charge income on charged-oÅ accounts(1) ÏÏÏÏÏÏÏÏÏ $ (45) $(1) $ (46)
Other income:Reversal of fee income on charged-oÅ accounts(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (40) Ì (40)Impact of FFIEC policies on securitized receivables(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (64) (2) (66)
Provision for credit losses:Owned charge-oÅs to comply with FFIEC policies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (155) (3) (158)Release of owned credit loss reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 116 4 120
Reduction to net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(120) $(1) $(121)
(1) Accrued Ñnance charges and fee income are reversed against the related revenue lines.(2) Represents charge-oÅ of principal, interest and fees on securitized receivables.
The adoption of FFIEC account management policies for our domestic private label and MasterCard/Visareceivables revises existing policies regarding restructuring of past due accounts for certain receivables on a go-forward basis. Certain domestic MasterCard/Visa receivables were following these policies prior to December2004. The requirements before such accounts can now be re-aged are as follows: (a) the borrower is requiredto make three consecutive minimum monthly payments or a lump sum equivalent; (b) the account must be in
51
HSBC Finance Corporation
existence for a minimum of nine months; and (c) the account should not be re-aged more than once withinany twelve-month period and not more than twice in a Ñve-year period. An account may be re-aged after itenters a work-out program, including internal and third party debt counseling services, but only after receipt ofat least three consecutive minimum monthly payments or the equivalent cumulative amount, as agreed uponunder the work-out or debt management program. Re-aging for work-out purposes may be limited to once in aÑve-year period and is in addition to the once in twelve months and twice in Ñve year limits.
We do not expect the adoption of FFIEC charge-oÅ and account management policies for our domesticprivate label and MasterCard and Visa portfolios to have a signiÑcant impact on our business model or on ourresults of operations or our cash Öows in future periods.
Delinquency and Charge-oÅ Policies and Practices Our delinquency and net charge-oÅ ratios reÖect, amongother factors, changes in the mix of loans in our portfolio, the quality of our receivables, the average age of ourloans, the success of our collection and customer account management eÅorts, bankruptcy trends and generaleconomic conditions. The levels of personal bankruptcies also have a direct eÅect on the asset quality of ouroverall portfolio and others in our industry.
Our credit and portfolio management procedures focus on risk-based pricing and eÅective collection andcustomer account management eÅorts for each loan. We believe our credit and portfolio management processgives us a reasonable basis for predicting the credit quality of new accounts. This process is based on ourexperience with numerous marketing, credit and risk management tests. We also believe that our frequent andearly contact with delinquent customers, as well as restructuring and other customer account managementtechniques which are designed to optimize account relationships, are helpful in maximizing customercollections. See Note 2, ""Summary of SigniÑcant Accounting Policies,'' in the accompanying consolidatedÑnancial statements for a description of our charge-oÅ and nonaccrual policies by product.
Our charge-oÅ policies focus on maximizing the amount of cash collected from a customer while not incurringexcessive collection expenses on a customer who will likely be ultimately uncollectible. We believe our policiesare responsive to the speciÑc needs of the customer segment we serve. Our real estate and auto Ñnance charge-oÅ policies consider customer behavior in that initiation of foreclosure or repossession activities often promptsrepayment of delinquent balances. Our collection procedures and charge-oÅ periods, however, are designed toavoid ultimate foreclosure or repossession whenever it is reasonably economically possible. Our MasterCard/Visa charge-oÅ policy is generally consistent with industry practice. Charge-oÅ periods for our personal non-credit card product and, prior to December 2004, our domestic private label product were designed to beresponsive to our customer needs and may therefore be longer than bank competitors who serve a diÅerentmarket. Except as discussed above, our policies have generally been consistently applied in all materialrespects. Our loss reserve estimates consider our charge-oÅ policies to ensure appropriate reserves exist forproducts with longer charge-oÅ lives. We believe our current charge-oÅ policies are appropriate and result inproper loss recognition.
Delinquency Ó Owned Basis
Our policies and practices for the collection of consumer receivables, including our customer accountmanagement policies and practices, permit us to reset the contractual delinquency status of an account tocurrent, based on indicia or criteria which, in our judgment, evidence continued payment probability. Whenwe use a customer account management technique, we may treat the account as being contractually currentand will not reÖect it as a delinquent account in our delinquency statistics. However, if the accountsubsequently experiences payment defaults and becomes at least two months contractually delinquent, it willbe reported in our delinquency ratios. See ""Customer Account Management Policies and Practices'' forfurther detail of our practices.
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HSBC Finance Corporation
The following table summarizes two-months-and-over contractual delinquency (as a percent of consumerreceivables):
2004 2003
Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31
Total consumerÏÏÏÏÏÏÏÏÏÏ 4.07% 4.43% 4.57% 5.01% 5.36% 5.36% 5.38% 5.50%
Compared to September 30, 2004, our total consumer delinquency ratio was lower at December 31, 2004. Thisdecrease is consistent with improvements in early delinquency trends we began to experience in the fourthquarter of 2003 as a result of improvements in the economy, better underwriting standards and improved creditquality of originations. The overall decrease in delinquency in our real estate secured portfolio reÖectsreceivable growth, improved collection eÅorts, the recent trend of better quality in new originations andimproved economic conditions. The increase in auto Ñnance delinquencies reÖects normal seasonal patterns.The decrease in MasterCard/Visa delinquencies reÖects changes in receivable mix resulting from lowersecuritization levels and the beneÑt of seasonal receivable growth. The delinquency ratio for private label atDecember 31, 2004, reÖects the delinquency in our foreign private label portfolio that was not sold to HSBCBank USA in December 2004. All other periods include the domestic private label portfolio. The decrease inpersonal non-credit card delinquency reÖects the positive impact of receivable growth as well as improvedcollection eÅorts and economic conditions.
Compared to December 31, 2003, total consumer delinquency ratio decreased 129 basis points as all productsreported lower delinquency levels generally as a result of better underwriting standards and improved creditquality of originations as well as overall and improvements in the economy.
See ""Credit Quality Statistics Ó Managed Basis'' for additional information regarding our managed basiscredit quality. See ""Customer Account Management Policies and Practices'' regarding the treatment ofrestructured accounts and accounts subject to forbearance and other customer account management tools.
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HSBC Finance Corporation
Net Charge-oÅs of Consumer Receivables Ó Owned Basis
The following table summarizes net charge-oÅ of consumer receivables as a percent of average consumerreceivables:
2004 2003(1)
2002Quarter ended (Annualized) Quarter ended (Annualized)Full Full Fullyear Dec. 31 Sept. 30 June 30 Mar. 31 year Dec. 31 Sept. 30 June 30 Mar. 31 year
Real estate charge-offs and REOexpense as a percent ofaverage real estate securedreceivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.38% 1.17% 1.31% 1.47% 1.63% 1.42% 1.37% 1.35% 1.46% 1.52% 1.29%
(1) We adopted FSP 144-1 in November 2003. The adoption increased real estate charge-offs by $9.1 million and auto finance charge-offs by$1.2 million for the quarter ended December 31, 2003. The adoption increased real estate charge-offs by 7 basis points for the quarterended December 31, 2003 and 1 basis point for the full year 2003, auto finance charge-offs by 12 basis points for the quarter endedDecember 31, 2003 and 4 basis points for the full year 2003, and total consumer charge-offs by 4 basis points for the quarter endedDecember 31, 2003 and 1 basis point for the full year 2003. The impact on prior periods was not material.
(2) The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios in December 2004 increasedprivate label net charge-oÅs by $155 million (432 basis points), MasterCard/Visa net charge-oÅs by $3 million (9 basis points) andtotal consumer net charge-oÅ by $158 million (57 basis points) for the quarter ended December 31, 2004. Full year, the adoptionincreased private label net charge-oÅs by 119 basis points, MasterCard/Visa net charge-oÅs by 2 basis points and total consumer netcharge-oÅs by 16 basis points.
Net charge-oÅs as a percentage of average consumer receivables decreased in 2004 as the lower delinquencylevels we have been experiencing due to an improving economy are having an impact on charge-oÅs. Averagereceivable growth also positively impacted the ratios. The decrease in our net charge-oÅ percentage wasreduced by the adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visaportfolios. Excluding the additional charge-oÅs resulting from the adoption of these FFIEC policies, netcharge-oÅs for the full year 2004 decreased 22 basis points compared to 2003. Our real estate secured portfolioexperienced increases in net charge-oÅs reÖecting lower estimates of net realizable value as a result of processchanges in 2004 to better estimate property values at the time of foreclosure. The decrease in the auto Ñnanceratio reÖects receivable growth with improved credit quality of originations, improved collections and betterunderwriting standards. The decrease in the MasterCard/Visa ratio reÖects changes in receivable mix,seasonality and improved credit quality of originations. The decrease in net charge-oÅs in the personal non-credit card is a result of improved credit quality and receivable growth as well as improved economicconditions.
While net consumer charge-oÅs as a percentage of average receivables decreased during 2004, we experiencedan increase in overall net charge-oÅ dollars in 2004. This is due to higher delinquencies due to adverseeconomic conditions which existed in 2003 migrating to charge-oÅ in 2004 as well as to higher receivablelevels in 2004.
The decrease in real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables in 2004 over the 2003 ratio was the result of the improved economy, better credit quality of recentoriginations and fewer bankruptcy Ñlings in 2004.
The increases in charge-oÅ ratios in 2003 compared to 2002 reÖect higher levels of new bankruptcy Ñlings andthe weak economy in 2003, including higher unemployment which negatively aÅected charge-oÅ rates in allproducts while average receivable growth positively impacted all products except personal non-credit card.Average receivable growth includes portfolio acquisitions in our MasterCard and Visa and private label
54
HSBC Finance Corporation
portfolios and newly originated loans acquired from strategic alliances in our auto Ñnance portfolio. AutoÑnance charge-oÅ rates also reÖect improved underwriting and lower securitization levels as more originationvolume is remaining on our balance sheet rather than being securitized. Loss severities on repossessed vehiclesin our auto Ñnance business remained high in 2003, but had stabilized from the 2002 levels. Our private labelcharge-oÅ rates also reÖect improved underwriting, collections and credit models. Charge-oÅ rates in ourpersonal non-credit card portfolio reÖect continued maturation of the portfolio as well as reduced originations.
The increase in real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables in 2003 over the 2002 ratio was the result of the seasoning of our portfolios, higher loss severitiesand higher bankruptcy Ñlings.
See ""Credit Quality Statistics Ó Managed Basis'' for additional information regarding our managed basiscredit quality.
Total nonperforming receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,521 4,050 3,528
Real estate ownedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 587 631 427
Total nonperforming assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,108 $4,681 $3,955
The decrease in nonaccrual receivables is primarily due to improved credit quality and collection eÅorts,partially oÅset by growth. Accruing consumer receivables 90 or more days delinquent at December 31, 2004,2003 and 2002 includes domestic MasterCard/Visa and private label credit card receivables which isconsistent with industry practice. The decrease in accruing consumer receivables 90 or more days delinquentat December 31, 2004 reÖects the impact of the bulk sale of our domestic private label receivables portfolio inDecember 2004. Total nonperforming assets at December 31, 2004 decreased for the reasons discussed above.
Credit Loss Reserves We maintain credit loss reserves to cover probable losses of principal, interest and fees,including late, overlimit and annual fees. Credit loss reserves are based on a range of estimates and areintended to be adequate but not excessive. We estimate probable losses for owned consumer receivables usinga roll rate migration analysis that estimates the likelihood that a loan will progress through the various stagesof delinquency, or buckets, and ultimately charge oÅ. This analysis considers delinquency status, lossexperience and severity and takes into account whether loans are in bankruptcy, have been restructured orrewritten, or are subject to forbearance, an external debt management plan, hardship, modiÑcation, extensionor deferment. Our credit loss reserves also take into consideration the loss severity expected based on theunderlying collateral, if any, for the loan in the event of default. Delinquency status may be aÅected bycustomer account management policies and practices, such as the restructure of accounts, forbearanceagreements, extended payment plans, modiÑcation arrangements, external debt management programs, loanrewrites and deferments. If customer account management policies, or changes thereto, shift loans from a""higher'' delinquency bucket to a ""lower'' delinquency bucket, this will be reÖected in our roll rate statistics.To the extent that restructured accounts have a greater propensity to roll to higher delinquency buckets, thiswill be captured in the roll rates. Since the loss reserve is computed based on the composite of all of thesecalculations, this increase in roll rate will be applied to receivables in all respective delinquency buckets, whichwill increase the overall reserve level. In addition, loss reserves on consumer receivables are maintained toreÖect our judgment of portfolio risk factors that may not be fully reÖected in the statistical roll ratecalculation. Risk factors considered in establishing loss reserves on consumer receivables include recent
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HSBC Finance Corporation
growth, product mix, bankruptcy trends, geographic concentrations, economic conditions, portfolio seasoning,account management policies and practices and current levels of charge-oÅs and delinquencies.
While our credit loss reserves are available to absorb losses in the entire portfolio, we speciÑcally consider thecredit quality and other risk factors for each of our products. We recognize the diÅerent inherent losscharacteristics in each of our products as well as customer account management policies and practices and riskmanagement/collection practices. Charge-oÅ policies are also considered when establishing loss reserverequirements to ensure the appropriate reserves exist for products with longer charge-oÅ periods. We alsoconsider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-oÅs indeveloping our loss reserve estimate. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are inÖuenced by factors outside of ourcontrol, such as consumer payment patterns and economic conditions, there is uncertainty inherent in theseestimates, making it reasonably possible that they could change.
The following table sets forth owned basis credit loss reserves for the periods indicated:At December 31,
2004 2003 2002 2001 2000
(dollars are in millions)
Owned credit loss reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,625 $3,793 $3,333 $2,663 $2,112Reserves as a percent of receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.39% 4.11% 4.04% 3.33% 3.14%Reserves as a percent of net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89.9(1) 105.7 106.5 110.5 109.9Reserves as a percent of nonperforming loansÏÏÏÏÏÏÏÏÏÏÏ 103.0 93.7 94.5 92.7 91.1
(1) In December 2004, we adopted FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios andsubsequently sold the domestic private label receivable portfolio. These events had a signiÑcant impact on this ratio. Reserves as apercentage of net charge-oÅs excluding domestic private label net charge-oÅs and charge-oÅ relating to the adoption of FFIEC was109.2% at December 31, 2004.
Owned credit loss reserve levels at December 31, 2004 reflect the sale of our domestic private label portfoliowhich decreased credit loss reserves by $505 million. Excluding this sale, owned credit loss reserves would haveincreased during 2004 reflecting growth in our loan portfolio partially offset by improved asset quality. In 2004,we recorded owned loss provision greater than net charge-offs of $301 million. Excluding the impact of adoptingFFIEC charge-off policies for owned domestic private label and MasterCard/Visa portfolios, we recorded ownedloss provision $421 million greater than net charge-offs in 2004. We increased owned credit loss reserves in 2003by recording owned loss provision greater than net charge-offs of $380 million. Reserve levels at December 31,2003 also reflect receivable growth.
We are experiencing a shift in our loan portfolio to higher credit quality and lower yielding receivables,particularly real estate secured and auto Ñnance receivables. Reserves as a percentage of receivables atDecember 31, 2004 were lower than at December 31, 2003 as a result of improved credit quality. Reserves as apercentage of receivables at December 31, 2003 were higher than at December 31, 2002 as a result of the saleof $2.8 billion of higher quality real estate secured loans to HSBC Bank USA in December 2003. Had thissale not occurred, reserves as a percentage of receivables at December 2003 would have been lower than 2002as a result of improving credit quality in the latter half of 2003 as delinquency rates stabilized and charge-oÅlevels began to improve.
The trends in the reserve ratios for 2003, 2002 and 2001 reflect the impact of the weak economy, higherdelinquency levels, and uncertainty as to the ultimate impact the weakened economy would have on delinquencyand charge-off levels. The ratios in 2000 reflect improving credit quality trends and the benefits of the continuedrun-off of our undifferentiated Household Bank branded MasterCard and Visa portfolio.
Reserves as a percentage of nonperforming loans increased in 2004 as nonperforming loans declined due toimproved credit quality and the private label receivable sale while loss reserve levels declined at a slower pacedue to receivable growth.
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HSBC Finance Corporation
For securitized receivables, we also record a provision for estimated probable losses that we expect to incurunder the recourse provisions. The following table sets forth managed credit loss reserves for the periodsindicated:
At December 31, 2004 2003 2002 2001 2000
(dollars are in millions)
Managed credit loss reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,515 $6,167 $5,092 $3,811 $3,194Reserves as a percent of receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.73% 5.20% 4.74% 3.78% 3.65%Reserves as a percent of net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 79.6(1) 117.4 113.8 110.7 111.1Reserves as a percent of nonperforming loansÏÏÏÏÏÏÏÏÏÏÏ 108.4 118.0 112.6 105.0 107.0
(1) In December 2004 we adopted FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios andsubsequently sold the domestic private label receivable portfolio. These events had a signiÑcant impact on this ratio. Reserves as apercentage of net charge-oÅs excluding domestic private label net charge-oÅs and charge-oÅ relating to the adoption of FFIECpolicies was 96.0% on a managed basis at December 31, 2004.
Managed credit loss reserves at December 31, 2004 decreased as a result of changes in securitization levels,including our decision to structure new collateralized funding transactions as secured Ñnancings and theDecember 2004 domestic private label receivable sale. Securitized receivables were $12 billion lower atDecember 31, 2004 compared with the prior year.
See the ""Analysis of Credit Loss Reserves Activity,'' ""Reconciliations to GAAP Financial Measures'' andNote 5, ""Credit Loss Reserves,'' to the accompanying consolidated Ñnancial statements for additionalinformation regarding our owned basis and managed basis loss reserves.
Customer Account Management Policies and Practices Our policies and practices for the collection ofconsumer receivables, including our customer account management policies and practices, permit us to resetthe contractual delinquency status of an account to current, based on indicia or criteria which, in ourjudgment, evidence continued payment probability. Such policies and practices vary by product and aredesigned to manage customer relationships, maximize collection opportunities and avoid foreclosure orrepossession if reasonably possible. If the account subsequently experiences payment defaults, it will againbecome contractually delinquent.
In the third quarter of 2003, we implemented certain changes to our restructuring policies. These changeswere intended to eliminate and/or streamline exception provisions to our existing policies and were generallyeÅective for receivables originated or acquired after January 1, 2003. Receivables originated or acquired priorto January 1, 2003 generally are not subject to the revised restructure and customer account managementpolicies. However, for ease of administration, in the third quarter of 2003, our mortgage services businesselected to adopt uniform policies for all products regardless of the date an account was originated or acquired.Implementation of the uniform policy by mortgage services had the eÅect of only counting restructuresoccurring on or after January 1, 2003 in assessing restructure eligibility for purposes of the limitation that noaccount may be restructured more than four times in a rolling sixty-month period. Other business units mayalso elect to adopt uniform policies. The changes adopted in the third quarter of 2003 have not had asigniÑcant impact on our business model or on our results of operations as these changes have generally beenphased in as new receivables were originated or acquired. As discussed in more detail below, we also revisedcertain policies for our domestic private label credit card and MasterCard and Visa portfolios in December2004.
Approximately two-thirds of all restructured receivables are secured products, which in general have less lossseverity exposure because of the underlying collateral. Credit loss reserves take into account whether loanshave been restructured, rewritten or are subject to forbearance, an external debt management plan,modiÑcation, extension or deferment. Our credit loss reserves also take into consideration the loss severityexpected based on the underlying collateral, if any, for the loan.
Our restructuring policies and practices vary by product and are described in the table that follows and reÖectthe revisions from the adoption of FFIEC charge-oÅ and account management policies for our domestic
57
HSBC Finance Corporation
private label and MasterCard/Visa receivables. The fact that the restructuring criteria may be met for aparticular account does not require us to restructure that account, and the extent to which we restructureaccounts that are eligible under the criteria will vary depending upon our view of prevailing economicconditions and other factors which may change from period to period. In addition, for some products, accountsmay be restructured without receipt of a payment in certain special circumstances (e.g. upon reaÇrmation of adebt owed to us in connection with a Chapter 7 bankruptcy proceeding). We use account restructuring as anaccount and customer management tool in an eÅort to increase the value of our account relationships, andaccordingly, the application of this tool is subject to complexities, variations and changes from time to time.These policies and practices are continually under review and assessment to assure that they meet the goalsoutlined above, and accordingly, we modify or permit exceptions to these general policies and practices fromtime to time. In addition, exceptions to these policies and practices may be made in speciÑc situations inresponse to legal or regulatory agreements or orders.
In the policies summarized below, ""hardship restructures'' and ""workout restructures'' refer to situations inwhich the payment and/or interest rate may be modiÑed on a temporary or permanent basis. In each case, thecontractual delinquency status is reset to current. ""External debt management plans'' refers to situations inwhich consumers receive assistance in negotiating or scheduling debt repayment through public or privateagencies such as Consumers Credit Counseling Services.
Restructuring Policies and Practices
Historical Restructuring Following Changes Implemented in the
Policies and Practices(1),(2),(3)
Third Quarter 2003 and in December 2004 (1),(2),(3)
Real estate secured Real estate securedReal Estate Ó Overall Real Estate Ó Overall
‚ Accounts may be restructured upon receipt of‚ An account may be restructured if we receive twotwo qualifying payments within the 60 daysqualifying payments within the 60 days precedingpreceding the restructurethe restructure; we may restructure accounts in
hardship, disaster or strike situations with one ‚ Accounts generally are not eligible forqualifying payment or no payments restructure until nine months after origination
‚ Accounts that have filed for Chapter 7 ‚ Accounts will be limited to four collectionbankruptcy protection may be restructured upon restructures in a rolling sixty-month periodreceipt of a signed reaffirmation agreement ‚ Accounts whose borrowers have Ñled for
‚ Accounts subject to a Chapter 13 plan Ñled with Chapter 7 bankruptcy protection may bea bankruptcy court generally require one restructured upon receipt of a signedqualifying payment to be restructured reaÇrmation agreement
‚ Except for bankruptcy reaÇrmation and Ñled ‚ Accounts whose borrowers are subject to aChapter 13 plans, agreed automatic payment Chapter 13 plan Ñled with a bankruptcy courtwithdrawal or hardship/disaster/strike, accounts generally may be restructured upon receipt ofare generally limited to one restructure every one qualifying paymenttwelve-months ‚ Except for bankruptcy reaÇrmation and Ñled
‚ Accounts generally are not eligible for Chapter 13 plans, accounts will generally not berestructure until they are on the books for at restructured more than once in a twelve-monthleast six months period
‚ Accounts whose borrowers agree to pay byautomatic withdrawal are generally restructuredupon receipt of one qualifying payment(4)
Real Estate Ó Consumer Lending Real Estate Ó Mortgage Services(5)
‚ Accounts whose borrowers agree to pay by ‚ Accounts will generally not be eligible forautomatic withdrawal are generally restructured restructure until nine months after originationupon receipt of one qualifying payment and six months after acquisition
Auto Ñnance Auto Ñnance
‚ Accounts may be extended if we receive one ‚ Accounts may generally be extended uponqualifying payment within the 60 days preceding receipt of two qualifying payments within the
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HSBC Finance Corporation
Restructuring Policies and Practices
Historical Restructuring Following Changes Implemented in the
Policies and Practices(1),(2),(3)
Third Quarter 2003 and in December 2004 (Continued)(1),(2),(3)
the extension 60 days preceding the extension
‚ Accounts may be extended no more than three ‚ Accounts may be extended by no more thanmonths at a time and by no more than three three months at a timemonths in any twelve-month period ‚ Accounts will be limited to four extensions in a
‚ Extensions are limited to six months over the rolling sixty-month period, but in no case will ancontractual life account be extended more than a total of six
months over the life of the account
‚ Accounts that have filed for Chapter 7 ‚ Accounts will be limited to one extension everybankruptcy protection may be restructured upon six monthsreceipt of a signed reaffirmation agreement ‚ Accounts will not be eligible for extension until
‚ Accounts whose borrowers are subject to a they are on the books for at least six monthsChapter 13 plan may be restructured upon Ñling ‚ Accounts whose borrowers have Ñled forof the plan with a bankruptcy court Chapter 7 bankruptcy protection may be
restructured upon receipt of a signedreaÇrmation agreement
‚ Accounts whose borrowers are subject to aChapter 13 plan may be restructured upon Ñlingof the plan with the bankruptcy court.
MasterCard and Visa MasterCard and VisaAccounts originated between January 2003 Ó‚ Typically, accounts qualify for restructuring if weDecember 2004receive two or three qualifying payments prior to‚ Accounts typically qualiÑed for restructuring ifthe restructure, but accounts in approved
we received two or three qualifying paymentsexternal debt management programs mayprior to the restructure, but accounts in approvedgenerally be restructured upon receipt of oneexternal debt management programs couldqualifying paymentgenerally be restructured upon receipt of one
‚Generally, accounts may be restructured once qualifying payment.every six months
‚ Generally, accounts could have beenrestructured once every six months.
Beginning in December 2004, all accountsregardless of origination date‚ Domestic accounts qualify for restructuring if we
receive three consecutive minimum monthlypayments or a lump sum equivalent.
‚ Domestic accounts qualify for restructuring ifthe account has been in existence for a minimumof nine months and the account has not beenrestructured more than once in any twelve-month period and not more than twice in a Ñve-year period.
‚ Domestic accounts entering third party debtcounseling programs are limited to onerestructure in a Ñve-year period in addition to thegeneral limits of one restructure in a twelve-month period and two restructures in a Ñve-yearperiod.
Private label(6)
Private label(6)
‚ An account may generally be restructured if we Prior to December 2004 for accounts originatedreceive one or more qualifying payments, after October 2002depending upon the merchant.
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HSBC Finance Corporation
Restructuring Policies and Practices
Historical Restructuring Following Changes Implemented in the
Policies and Practices(1),(2),(3)
Third Quarter 2003 and in December 2004 (Continued)(1),(2),(3)
‚ For certain merchants, receipt of two or three‚ Restructuring is limited to once every six monthsqualifying payments was required, except(or longer, depending upon the merchant) foraccounts in an approved external debtrevolving accounts and once every twelve-management program could be restructuredmonths for closed-end accountsupon receipt of one qualifying payment.
‚ Accounts must have been on the books for at leastnine months to be restructured and a minimum oftwo qualifying payments were received within the60 days preceding the restructure.
‚ Accounts were not eligible for subsequentrestructure until twelve months after a priorrestructure and upon receipt of three qualifyingpayments within the 90 days preceding therestructure.
Beginning in December 2004, all accountsregardless of origination date
‚ Domestic accounts qualify for restructuring if wereceive three consecutive minimum monthlypayments or a lump sum equivalent.
‚ Domestic accounts qualify for restructuring ifthe account has been in existence for a minimumof nine months and the account has not beenrestructured more than once in any twelve-month period and not more than twice in a Ñve-year period.
‚ Domestic accounts entering a workout program,including internal and third party debtcounseling programs, are limited to onerestructure in a Ñve-year period in addition to thegeneral limits of one restructure in a twelve-month period and two restructures in a Ñve-yearperiod.
Personal non-credit card Personal non-credit card
‚ Accounts may be restructured if we receive one ‚ Accounts may be restructured upon receipt ofqualifying payment within the 60 days preceding two qualifying payments within the 60 daysthe restructure; may restructure accounts in a preceding the restructurehardship/disaster/strike situation with one ‚ Accounts will be limited to one restructure everyqualifying payment or no payments six months
‚ If an account is never more than 90 days ‚ Accounts will be limited to four collectiondelinquent, it may generally be restructured up restructures in a rolling sixty-month periodto three times per year
‚ Accounts will not be eligible for restructure until‚ If an account is ever more than 90 days six months after origination
delinquent, generally it may be restructured withone qualifying payment no more than four timesover its life; however, generally the account maythereafter be restructured if two qualifyingpayments are received
‚ Accounts subject to programs for hardship orstrike may require only the receipt of reducedpayments in order to be restructured; disastermay be restructured with no payments
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HSBC Finance Corporation
(1) We employ account restructuring and other customer account management policies and practices as Öexible customer accountmanagement tools as criteria may vary by product line. In addition to variances in criteria by product, criteria may also vary within aproduct line. Also, we continually review our product lines and assess restructuring criteria and they are subject to modiÑcation orexceptions from time to time. Accordingly, the description of our account restructuring policies or practices provided in this tableshould be taken only as general guidance to the restructuring approach taken within each product line, and not as assurance thataccounts not meeting these criteria will never be restructured, that every account meeting these criteria will in fact be restructured orthat these criteria will not change or that exceptions will not be made in individual cases. In addition, in an eÅort to determine optimalcustomer account management strategies, management may run more conservative tests on some or all accounts in a product line forÑxed periods of time in order to evaluate the impact of alternative policies and practices.
(2) For our United Kingdom business, all portfolios have a consistent account restructure policy. An account may be restructured if wereceive two or more qualifying payments within two calendar months, limited to one restructure every 12 months, with a lifetime limitof three times. In hardship situations an account may be restructured if a customer makes three consecutive qualifying monthlypayments within the last three calendar months. Only one hardship restructure is permitted in the life of a loan. There were no changesto the restructure policies of our United Kingdom business in 2003 or 2004.
(3) Historically, policy changes are not applied to the entire portfolio on the date of implementation but are applied to new, or recentlyoriginated or acquired accounts. However, the policies adopted in the third quarter of 2003 for the mortgage services business and thefourth quarter of 2004 for the domestic private label and MasterCard/Visa credit card portfolios were applied more broadly. Thepolicy changes for the mortgage services business which occurred in the third quarter of 2003, unless otherwise noted, were generallyapplied to accounts originated or acquired after January 1, 2003 and the historical restructuring policies and practices are eÅective forall accounts originated or acquired prior to January 1, 2003. Implementation of this uniform policy had the eÅect of only countingrestructures occurring on or after January 1, 2003 in assessing restructure eligibility for the purpose of the limitation that no accountmay be restructured more than four times in a rolling 60 month period. These policy changes adopted in the third quarter of 2003 didnot have a signiÑcant impact on our business model or results of operations as the changes are, in eÅect, phased in as receivables wereoriginated or acquired. For the adoption of FFIEC policies which occurred in the fourth quarter of 2004, the policies were eÅectiveimmediately for all receivables in the domestic private label credit card and the MasterCard and Visa portfolios. Other business unitsmay also elect to adopt uniform policies in future periods.
(4) Our mortgage services business implemented this policy for all accounts eÅective March 1, 2004.(5) Prior to January 1, 2003, accounts that had made at least six qualifying payments during the life of the loan and that agreed to pay by
automatic withdrawal were generally restructured with one qualifying payment.(6) For our Canadian business, private label accounts are limited to one restructure every four months and if originated or acquired after
January 1, 2003, two qualifying payments must be received, the account must be on the books for at least six months, at least sixmonths must have elapsed since the last restructure, and there may be no more than four restructures in a rolling 60 month period.
In addition to our restructuring policies and practices, we employ other customer account managementtechniques, which we typically use on a more limited basis, that are similarly designed to manage customerrelationships, maximize collection opportunities and avoid foreclosure or repossession if reasonably possible.These additional customer account management techniques include, at our discretion, actions such asextended payment arrangements, approved external debt management plans, forbearance, modiÑcations, loanrewrites and/or deferment pending a change in circumstances. We typically use these customer accountmanagement techniques with individual borrowers in transitional situations, usually involving borrowerhardship circumstances or temporary setbacks that are expected to aÅect the borrower's ability to pay thecontractually speciÑed amount for some period of time. These actions vary by product and are under continualreview and assessment to determine that they meet the goals outlined above. For example, under aforbearance agreement, we may agree not to take certain collection or credit agency reporting actions withrespect to missed payments, often in return for the borrower's agreeing to pay us an extra amount inconnection with making future payments. In some cases, these additional customer account managementtechniques may involve us agreeing to lower the contractual payment amount and/or reduce the periodicinterest rate. In most cases, the delinquency status of an account is considered to be current if the borrowerimmediately begins payment under the new account terms. When we use a customer account managementtechnique, we may treat the account as being contractually current and will not reÖect it as a delinquentaccount in our delinquency statistics. However, if the account subsequently experiences payment defaults, itwill again become contractually delinquent. We generally consider loan rewrites to involve an extension of anew loan, and such new loans are not reÖected in our delinquency or restructuring statistics.
61
HSBC Finance Corporation
The tables below summarize approximate restructuring statistics in our managed basis domestic portfolio. Wereport our restructuring statistics on a managed basis only because the receivables that we securitize aresubject to underwriting standards comparable to our owned portfolio, are generally serviced and collectedwithout regard to ownership and result in a similar credit loss exposure for us. As previously reported, in priorperiods we used certain assumptions and estimates to compile our restructure statistics. We also stated that wecontinue to enhance our ability to capture and segment restructure data across all business units. In the tablesthat follow, the restructure statistics presented for December 31, 2004 have been compiled using enhancedsystemic counters and reÑned assumptions and estimates. As a result of the system enhancements, forJune 30, 2004 and subsequent periods we exclude from our reported statistics loans that have been reported ascontractually delinquent that have been reset to a current status because we have determined that the loanshould not have been considered delinquent (e.g.,payment application processing errors). Statistics reportedfor December 31, 2003 include such loans. When comparing restructuring statistics from diÅerent periods, thefact that our restructure policies and practices will change over time, that exceptions are made to thosepolicies and practices, and that our data capture methodologies will be enhanced over time, should be takeninto account.
Total Restructured by Restructure Period Ó Domestic Portfolio(1)
(Managed Basis)
At December 31, 2004(3)
2003(4)
Never restructuredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 86.7% 84.4%
Restructured:
Restructured in the last 6 months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.1 6.7
Restructured in the last 7-12 months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.2 3.8
(1) Excludes foreign businesses, commercial and other.
(2) Total including foreign businesses was 12.3 percent at December 31, 2004 and 14.7 percent at December 31, 2003.
(3) As discussed above, statistics have been compiled using enhanced systemic counters and reÑned assumptions and estimates.
(4) Amounts also include accounts as to which the delinquency status has been reset to current for reasons other than restructuring (e.g.,
payment application processing errors) and compiled without the use of enhanced systemic counters and reÑned assumptions and
estimates.
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HSBC Finance Corporation
See ""Credit Quality Statistics'' for further information regarding owned basis and managed basis delinquency,charge-oÅs and nonperforming loans.
The amount of domestic and foreign managed receivables in forbearance, modiÑcation, credit card servicesapproved consumer credit counseling accommodations, rewrites or other customer account managementtechniques for which we have reset delinquency and that is not included in the restructured or delinquencystatistics was approximately $.4 billion or .4 percent of managed receivables at December 31, 2004 comparedwith $1.0 billion or .9 percent of managed receivables at December 31, 2003. For periods prior to June 30,2004, all credit card approved consumer credit counseling accommodations are included in the reportedstatistics in this paragraph. As a result of our system enhancements, we are now able to segregate which creditcard approved consumer credit counseling accommodations included resetting the contractual delinquencystatus to current after January 1, 2003. Such accounts are included in the December 31, 2004 restructurestatistics in the table above. Credit card credit counseling accommodations that did not include resettingcontractual delinquency status are not reported in the table above or the December 31, 2004 statistics in thisparagraph.
Geographic Concentrations The state of California accounts for 12 percent of our domestic owned portfolio.No other state accounts for more than 10 percent of either our domestic owned or managed portfolio. Becauseof our centralized underwriting, collections and processing functions, we can quickly change our creditstandards and intensify collection eÅorts in speciÑc locations. We believe this lowers risks resulting from suchgeographic concentrations.
Our foreign consumer operations located in the United Kingdom and the rest of Europe accounted for9 percent of owned consumer receivables and Canada accounted for 2 percent of owned consumer receivablesat December 31, 2004.
Liquidity and Capital Resources
While the funding synergies resulting from our acquisition by HSBC have allowed us to reduce our reliance ontraditional sources to fund our growth, our continued success and prospects for growth are dependent uponaccess to the global capital markets. Numerous factors, internal and external, may impact our access to andthe costs associated with issuing debt in these markets. These factors may include our debt ratings, overallcapital markets volatility and the impact of overall economic conditions on our business. We continue to focuson balancing our use of aÇliate and third-party funding sources to minimize funding expense whilemaximizing liquidity. As discussed below, we decreased our reliance on third-party debt and initialsecuritization funding during 2004 as we used proceeds from the sales of real estate secured receivables andour domestic private label receivable portfolio to HSBC Bank USA, debt issued to aÇliates and additionalsecured Ñnancings to assist in the funding of our businesses.
Because we are now a subsidiary of HSBC, our credit spreads relative to Treasuries have tightened comparedto those we experienced during the months leading up to the announcement of our acquisition by HSBC.Primarily as a result of these tightened credit spreads, reduced liquidity requirements and lower costs due toshortening the maturity of our liabilities, principally through increased issuance of commercial paper, werecognized cash funding expense savings of approximately $350 million in 2004 and $125 million in 2003compared to the funding costs we would have incurred using average spreads from the Ñrst half of 2002. It isanticipated that these tightened credit spreads and other funding synergies including asset transfers willeventually enable HSBC to realize annual cash funding expense savings, including external fee savings, inexcess of $1 billion per year as our existing term debt matures over the course of the next few years. Theportion of these savings to be realized by HSBC Finance Corporation will depend in large part upon theamount and timing of various initiatives between HSBC Finance Corporation and HSBC subsidiaries.Amortization of purchase accounting fair value adjustments to our external debt obligations as a result of theHSBC merger, reduced interest expense by $901 million in 2004 and $773 million in 2003.
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HSBC Finance Corporation
Debt due to aÇliates and other HSBC related funding are summarized in the following table:
Drawings on bank lines in the U.K. and Europe ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.5 3.4
Term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.0 1.3
Preferred securities issued by Household Capital Trust VIII to HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏ .3 .3
Total debt outstanding to HSBC subsidiariesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13.8 7.6
Debt outstanding to HSBC clients:
Euro commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.6 2.8
Term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .8 .4
Total debt outstanding to HSBC clients ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.4 3.2
Preferred stock held by HINO (held by HSBC at December 31, 2003)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.1 1.1
Cash received on sale of domestic private label credit card portfolio to HSBC Bank USA 12.4 -
Real estate secured receivable activity with HSBC Bank USA:
Cash received on sales (cumulative)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.7 2.8
Direct purchases from correspondents (cumulative) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.8 -
Reductions in real estate secured receivables sold to HSBC Bank USA ÏÏÏÏÏÏÏÏÏÏÏÏ (1.5) -
Total real estate secured receivable activity with HSBC Bank USA ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5.0 2.8
Total HSBC related fundingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $35.7 $14.7
At December 31, 2004, funding from HSBC, including debt issuances to HSBC subsidiaries and clients andpreferred stock held by HINO, represented Ñfteen percent of our total managed debt and preferred stockfunding. At December 31, 2003, funding from HSBC, including debt issuances to HSBC subsidiaries andclients and preferred stock held by HSBC, represented ten percent of our total managed debt and preferredstock funding.
Proceeds from the December 2004 domestic private label bulk receivable sale to HSBC Bank USA of$12.4 billion were used to pay down short-term domestic borrowings, including outstanding commercial paperbalances, and to fund operations. Excess liquidity from the sale was used to temporarily fund available for saleinvestments. Proceeds from the December 2003 sale of $2.8 billion of real estate secured loans to HSBC BankUSA, which at year-end 2003 had been temporarily held as securities available for sale, were used to pay-down domestic short-term borrowings in the Ñrst quarter of 2004. Proceeds from the March 2004 real estatesecured receivable sale were used to pay-down commercial paper balances which had been used as temporaryfunding in the Ñrst quarter of 2004 and to fund various debt maturities.
As of December 31, 2004, we had revolving credit facilities of $2.5 billion from HSBC domestically and$7.5 billion from HSBC subsidiaries in the U.K. which was increased to $8.0 billion in early 2005. A$4.0 billion revolving credit facility with HSBC Private Bank (Suisse) SA, which was new in 2004, expired onDecember 30, 2004. At December 31, 2004, $7.4 billion was outstanding under the U.K. lines and no balanceswere outstanding under the domestic lines. As of December 31, 2003, $3.4 billion was outstanding on the U.K.lines and no balances were outstanding on the domestic lines. We had derivative contracts with a notionalvalue of $62.6 billion, or approximately 87 percent of total derivative contracts, outstanding with HSBCaÇliates at December 31, 2004. At December 31, 2003, we had derivative contracts with a notional value of$39.7 billion, or approximately 58 percent of total derivative contracts, outstanding with HSBC aÇliates.
64
HSBC Finance Corporation
Securities totaled $4.3 billion at December 31, 2004 and $11.1 billion at December 31, 2003. Additionally atDecember 31, 2004, we had $2.7 billion of securities purchased under agreements to resell. Included in theDecember 31, 2003 balance was $2.4 billion dedicated to our credit card bank. In 2004, the investment levelsdedicated to our credit card bank were eliminated as a result of the funding and capital synergies resultingfrom our acquisition by HSBC. Our securities balance at the end of 2003 was also unusually high as a result ofthe cash received from the sale of $2.8 billion in real estate secured loans to HSBC Bank USA onDecember 31, 2003. Given the timing of the bulk sale of the domestic private label receivables to HSBC BankUSA on December 29, 2004, there was excess funding at December 31, 2004 even after paying down certaindebt obligations prior to year end. These remaining excess funds will be used to fund future asset growth.
Commercial paper, bank and other borrowings totaled $9.0 billion at December 31, 2004 and $9.1 billion atDecember 31, 2003. Included in this total was outstanding Euro commercial paper sold to customers of HSBCof $2.6 billion at December 31, 2004 and $2.8 billion at December 31, 2003. Commercial paper, bank andother borrowings decreased signiÑcantly during the fourth quarter of 2004 as the proceeds from the sale of thedomestic private label loan portfolio to HSBC Bank USA were used to reduce the outstanding balances.
Long term debt (with original maturities over one year) increased to $85.4 billion at December 31, 2004 from$79.6 billion at December 31, 2003. SigniÑcant issuances during 2004 included the following:
‚ $7.2 billion of domestic and foreign medium-term notes‚ $1.8 billion of foreign currency-denominated bonds (including $243 million which was issued to
customers of HSBC)‚ $1.4 billion of InterNotesSM (retail-oriented medium-term notes)‚ $4.5 billion of global debt‚ $5.1 billion of securities backed by home equity and auto Ñnance loans. For accounting purposes, these
transactions were structured as secured Ñnancings.
Selected capital ratios Ó In managing capital, we develop targets for tangible shareholder's(s') equity totangible managed assets (""TETMA''), tangible shareholder's(s') equity plus owned loss reserves to tangiblemanaged assets (""TETMA ° Owned Reserves'') and tangible common equity to tangible managed assets.These ratio targets are based on discussions with HSBC and rating agencies, risks inherent in the portfolio, theprojected operating environment and related risks, and any acquisition objectives. Our targets may changefrom time to time to accommodate changes in the operating environment or other considerations such as thoselisted above. We are committed to maintaining at least a mid-single ""A'' rating and as part of that eÅort willcontinue to review appropriate capital levels with our rating agencies.
In April 2004, Fitch Ratings revised our Rating Outlook to Positive from Stable and raised our Support Ratingto ""1'' from ""2''. In July 2004, Fitch Ratings raised our Senior Debt Rating to ""A°'' from ""A'' and raised ourSenior Subordinated Debt Rating and our Preferred Stock Rating to ""A'' from ""A¿''. In December 2004,Fitch Ratings again raised our Senior Debt Rating to ""AA¿'' from ""A°'' and our commercial paper rating to""F1°.'' Also in December 2004, Moody's Investor Service revised our rating outlook to A1 Positive from A1Stable.
65
HSBC Finance Corporation
Selected capital ratios are summarized in the following table:
Tangible common equity to tangible managed assets(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6.35 6.94
(1) TETMA, TETMA ° Owned Reserves and tangible common equity to tangible managed assets represent non-GAAP Ñnancial ratios
that are used by HSBC Finance Corporation management and certain rating agencies to evaluate capital adequacy and may diÅer
from similarly named measures presented by other companies. See ""Basis of Reporting'' for additional discussion on the use of non-
GAAP Ñnancial measures and ""Reconciliations to GAAP Financial Measures'' for quantitative reconciliations to the equivalent
GAAP basis Ñnancial measure.
HSBC Finance Corporation. HSBC Finance Corporation is an indirect wholly owned subsidiary of HSBCHoldings plc. On March 28, 2003, HSBC acquired Household International, Inc. by way of merger in apurchase business combination. EÅective January 1, 2004, HSBC transferred its ownership interest inHousehold to a wholly owned subsidiary, HSBC North America Holdings Inc., which subsequentlycontributed Household to its wholly owned subsidiary, HSBC Investments (North America) Inc. (""HINO'').On December 15, 2004, Household merged with its wholly owned subsidiary, Household Finance Corporation,with Household as the surviving entity. At the time of the merger, Household changed its name to ""HSBCFinance Corporation.''
HSBC Finance Corporation is the parent company that owns the outstanding common stock of itssubsidiaries. Our main source of funds is cash received from operations and subsidiaries in the form ofdividends and intercompany borrowings. In addition, we may receive cash from third parties or aÇliates byissuing preferred stock and debt.
HSBC Finance Corporation received dividends from its subsidiaries of $120 million in 2004 and $159 millionin 2003.
During the Ñrst quarter of 2003, in conjunction with the acquisition by HSBC, we redeemed outstandingshares of its 4.30, 4.50 and 5.00 percent cumulative preferred stock pursuant to their respective terms.Additionally, outstanding shares of its 7.625, 7.60, 7.50 and 8.25 percent preferred stock were converted intothe right to receive cash from HSBC in an amount equal to their liquidation value, plus accrued and unpaiddividends up to but not including the eÅective date of the merger which was an aggregate amount of$1.1 billion. In consideration of HSBC transferring suÇcient funds to make the payments described abovewith respect to the 7.625, 7.60, 7.50, and 8.25 percent preferred stock, we issued a new series of 6.50 percentcumulative preferred stock in the amount of $1.1 billion to HSBC on March 28, 2003. In September 2004,HNAH issued a new series of preferred stock totaling $1.1 billion to HSBC in exchange for our outstanding6.5 percent cumulative preferred stock. In October 2004, we paid an accrued dividend of $108 million on ourpreferred stock to HNAH. Also in October 2004, our immediate parent, HINO, issued a new series ofpreferred stock to HNAH in exchange for our 6.5 percent cumulative preferred stock.
In August 2003, we redeemed Household Capital Trusts I and IV. The preferred securities issued by theseTrusts totaled $275 million and were replaced with $275 million of 6.375% preferred securities of HouseholdCapital Trust VIII, which were issued to HSBC.
HSBC Finance Corporation has a number of obligations to meet with its available cash. It must be able toservice its debt and meet the capital needs of its subsidiaries. It also must pay dividends on its preferred stockand may pay dividends on its common stock. Dividends of $2.6 billion were paid to HINO, our immediate
66
HSBC Finance Corporation
parent company, on our common stock in 2004. No dividends were paid in 2003. HSBC Finance Corporationpaid $434 million in common and preferred dividends prior to the merger in 2003. We anticipate paying futuredividends to HINO, but will maintain our capital at levels necessary to maintain at least a mid-single ""A''rating either by limiting the dividends to or through capital contributions from our parent.
At various times, we will make capital contributions to our subsidiaries to comply with regulatory guidance,support receivable growth, maintain acceptable investment grade ratings at the subsidiary level, or providefunding for long-term facilities and technology improvements. No capital contributions to subsidiaries weremade by HSBC Finance Corporation in 2004 or 2003.
Subsidiaries Prior to December 15, 2004, we had two major subsidiaries: Household Finance Corporation(""HFC'') and Household Global Funding (""Global''). As previously discussed, on December 15, 2004, HFCmerged with and into Household International which changed its name to HSBC Finance Corporation. AtDecember 31, 2004, HSBC Finance had one major subsidiary, Global, and manages all domestic operationsheld by HFC prior to the merger.
Domestic Operations HSBC Finance Corporation's domestic operations are funded through the collection ofreceivable balances; issuing commercial paper, medium-term debt and long-term debt; securitizing andborrowing under secured Ñnancing facilities and selling consumer receivables. Domestically, HSBC FinanceCorporation markets its commercial paper primarily through an in-house sales force. The vast majority of ourdomestic medium-term notes and long-term debt is now marketed through subsidiaries of HSBC. Domesticmedium-term notes may also be marketed through our in-house sales force and investment banks. Long-termdebt may also be marketed through investment banks.
At December 31, 2004, advances from subsidiaries of HSBC for our domestic operations totaled $6.0 billion.At December 31, 2003, advances from subsidiaries of HSBC to the domestic operations totaled $3.9 billion.The interest rates on funding from HSBC subsidiaries are market-based and comparable to those availablefrom unaÇliated parties.
Outstanding commercial paper related to our domestic operations totaled $6.0 billion at December 31, 2004and $7.9 billion at December 31, 2003. The outstanding domestic commercial paper balance decreasedsigniÑcantly in the fourth quarter of 2004 as the proceeds from the bulk sale of the domestic private labelportfolio to HSBC Bank USA were used to reduce the outstanding balances. In 2003, following the HSBCmerger we established a new Euro commercial paper program, largely targeted towards HSBC clients, whichexpanded our European base. Under the Euro commercial paper program, commercial paper denominated inEuros, British pounds and U.S. dollars is sold to foreign investors. Outstanding Euro commercial paper sold tocustomers of HSBC totaled $2.6 billion at December 31, 2004 and $2.8 billion at December 31, 2003. Weactively manage the level of commercial paper outstanding to ensure availability to core investors whilemaintaining excess capacity within our internally-established targets as communicated with the ratingagencies.
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HSBC Finance Corporation
The following table shows various domestic debt issuances during 2004 and 2003.
2004 2003
(in billions)
Domestic medium term notes, excluding issuances to HSBC customers and subsidiariesof HSBCÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6.4 $3.8
Domestic medium term notes issued to HSBC customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .3 .2
Domestic medium term notes issued to subsidiaries of HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.6 .5
Foreign currency-denominated bonds, excluding issuances to HSBC customers andsubsidiaries of HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.0 4.7
Foreign currency-denominated bonds issued to HSBC customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .2 .2
Foreign currency-denominated bonds issued to subsidiaries of HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .6 .8
Global debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.5 5.1
Securities backed by home equity and auto Ñnance loans structured as secured Ñnancings ÏÏÏ 5.1 3.3
In order to eliminate future foreign exchange risk, currency swaps were used at the time of issuance to Ñx inU.S. dollars substantially all foreign-denominated notes in 2004 and 2003.
HSBC Finance Corporation issued securities backed by dedicated receivables of $5.1 billion in 2004 and$3.3 billion in 2003. For accounting purposes, these transactions were structured as secured Ñnancings,therefore, the receivables and the related debt remain on our balance sheet. At December 31, 2004, closed-endreal estate secured and auto Ñnance receivables totaling $10.3 billion secured $7.3 billion of outstanding debt.At December 31, 2003, closed-end real estate secured receivables totaling $8.0 billion secured $6.7 billion ofoutstanding debt.
HSBC Finance Corporation had committed back-up lines of credit totaling $9.9 billion at December 31, 2004for its domestic operations. Included in the December 31, 2004 total are $2.5 billion of revolving creditfacilities with HSBC. A $4.0 billion revolving credit facility with HSBC Private Bank (Suisse) SA, which wasnew in 2004 to allow temporary increases in commercial paper issuances in anticipation of the sale of theprivate label receivables to HSBC Bank USA, expired on December 30, 2004. None of these back-up lineswere drawn upon in 2004. The back-up lines expire on various dates through 2007. The most restrictiveÑnancial covenant contained in the back-up line agreements that could restrict availability is an obligation tomaintain minimum shareholder's equity of $6.9 billion which is substantially below our December 31, 2004common and preferred shareholder's equity balance of $16.9 billion.
At December 31, 2004, we had facilities with commercial and investment banks under which our domesticoperations may securitize up to $14.1 billion of receivables, including up to $12.2 billion of auto Ñnance,MasterCard, Visa, and personal non-credit card receivables and $1.9 billion of real estate secured receivables.As a result of additional liquidity capacity now available from HSBC and its subsidiaries, we have reduced ourtotal conduit capacity by $2.0 billion in 2004. Conduit capacity for real estate secured receivables wasincreased $.2 billion and capacity for other products was decreased $2.2 billion. The facilities are renewable atthe banks' option. At December 31, 2004, $8.2 billion of auto Ñnance, MasterCard and Visa, and personalnon-credit card receivables and $1.7 billion of real estate secured receivables were used in collateralizedfunding transactions structured either as securitizations or secured Ñnancings under these funding programs.In addition, we have available a $4 billion single seller mortgage facility (none of which was outstanding atDecember 31, 2004) structured as a secured Ñnancing. The amount available under the facilities will varybased on the timing and volume of public securitization transactions. Through existing term bank Ñnancingand new debt issuances, we believe we should continue to have adequate sources of funds.
Global Global includes our foreign subsidiaries in the United Kingdom, the rest of Europe and Canada.Global's assets were $14.3 billion at year-end 2004 and $11.7 billion at year-end 2003. Consolidated
68
HSBC Finance Corporation
shareholder's(s') equity includes the eÅect of translating our foreign subsidiaries' assets, liabilities andoperating results from their local currency into U.S. dollars.
Each foreign subsidiary conducts its operations using its local currency. While each foreign subsidiary usuallyborrows funds in its local currency, both our United Kingdom and Canadian subsidiaries have historicallyborrowed funds in foreign currencies. This allowed the subsidiaries to achieve a lower cost of funds than thatavailable at that time in their local markets. These borrowings were converted from foreign currencies to theirlocal currencies using currency swaps at the time of issuance.
United Kingdom Our United Kingdom operation is funded with HSBC subsidiary debt, long-term debt andsecuritizations of receivables. Prior to 2004, we also utilized wholesale deposits, commercial paper andshort-term and intermediate term bank lines of credit to fund our U.K. operations. The following tablesummarizes the funding of our United Kingdom operation:
Commercial paper, bank and other borrowings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - .8
Due to HSBC aÇliates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.4 3.4
Long term debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.0 2.4
At December 31, 2004, the $1.0 billion of long term debt was guaranteed by HSBC Finance Corporation.HSBC Finance Corporation receives a fee for providing the guarantee. Committed back-up lines of credit,which totaled approximately $5.3 billion at December 31, 2003, were eliminated in 2004 as our UnitedKingdom subsidiary received its 2004 funding directly from HSBC. At December 31, 2004, the U.K. hadsecuritized receivables totaling $922 million.
Canada Our Canadian operation is funded with commercial paper, intermediate debt and long-term debt.Outstanding commercial paper totaled $248 million at December 31, 2004 compared to $307 million a yearago. Intermediate and long-term debt totaled $1.9 billion at year-end 2004 compared to $1.5 billion a year ago.At December 31, 2004, $2.2 billion of the Canadian subsidiary's debt was guaranteed by HSBC FinanceCorporation for which it receives a fee for providing the guarantee. Committed back-up lines of credit forCanada were approximately $416 million at December 31, 2004. All of these back-up lines are guaranteed byHSBC Finance Corporation and none were used in 2004.
2005 Funding Strategy As discussed previously, the acquisition by HSBC has improved our access to thecapital markets as well as expanded our access to a worldwide pool of potential investors. Our currentestimated domestic funding needs and sources for 2005 are summarized in the table that follows.
(in billions)
Funding needs:
Net asset growth ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 14 - 18
Commercial paper, term debt and securitization maturities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30 - 34
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 - 4
Total funding needs, including growth ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 46 - 56
Funding sources:
External funding, including HSBC clients ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 42 - 50
HSBC and HSBC subsidiaries ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 - 6
Total funding sources ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 46 - 56
Commercial paper outstanding in 2005 is expected to be slightly higher than the December 31, 2004 balances,especially during the Ñrst three months of 2005 when commercial paper balances will be temporarily high due
69
HSBC Finance Corporation
to the seasonal activity of our TFS business. Approximately two-thirds of outstanding commercial paper isexpected to be domestic commercial paper sold both directly and through dealer programs. Euro commercialpaper, introduced in 2003, is expected to account for approximately one-third of outstanding commercialpaper and will be marketed predominately to HSBC clients.
Term debt issuances are expected to utilize several ongoing programs to achieve the desired funding.Approximately one-half of term debt funding is expected to be achieved through transactions includingU.S. dollar global and Euro transactions and large medium-term note (""MTN'') oÅerings. Domestic andforeign retail note programs are expected to account for approximately 20 percent of term debt issuances. Theremaining term debt issuances are expected to consist of smaller domestic and foreign currency MTNoÅerings.
As a result of our decision in 2004 to fund all new collateralized funding transactions as secured Ñnancings, weanticipate securitization levels to continue to decline in 2005. Because existing public MasterCard and Visacredit card transactions were structured as sales to revolving trusts that require replenishments of receivablesto support previously issued securities, receivables will continue to be sold to these trusts until the revolvingperiods end, the last of which is expected to occur in early 2008 based on current projections. In addition, wewill continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard/Visasecurities issued to conduits for a period of time in order to manage liquidity. Since our securitized receivableshave varying lives, it will take several years for these receivables to pay-oÅ and the related interest-only stripreceivables to be reduced to zero. The termination of sale treatment on new collateralized funding activityreduced our reported net income under U.S. GAAP. There was no impact, however, on cash received fromoperations or on U.K. GAAP reported results. Because we believe the market for securities backed byreceivables is a reliable, eÇcient and cost-eÅective source of funds, we will continue to use secured Ñnancingsof consumer receivables as a source of our funding and liquidity.
HSBC received regulatory approval in 2003 to provide the direct funding required by our United Kingdomoperations of up to $10.0 billion. Accordingly, in 2004 we eliminated all back-up lines of credit which hadpreviously supported our United Kingdom subsidiary. All new funding for our United Kingdom subsidiary isnow provided directly by HSBC. Our Canadian operation will continue to fund itself independently throughtraditional third-party funding sources such as commercial paper and medium term-notes. Funding needs in2005 are not expected to be signiÑcant for Canada.
Capital Expenditures We made capital expenditures of $96 million in 2004 and $115 million in 2003. Thedecrease in 2004 is due to certain technology costs that are now incurred by HTSU.
Commitments We also enter into commitments to meet the Ñnancing needs of our customers. In most cases,we have the ability to reduce or eliminate these open lines of credit. As a result, the amounts below do notnecessarily represent future cash requirements at December 31, 2004:
(in billions)
Private label, MasterCard and Visa credit cardsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $169.4
Other consumer lines of credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12.0
Open lines of credit(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $181.4
(1) Includes an estimate for acceptance of credit oÅers mailed to potential customers prior to December 31, 2004.
At December 31, 2004, our mortgage services business had commitments with numerous correspondents topurchase up to $285 million of real estate secured receivables at fair market value, subject to availability basedon underwriting guidelines speciÑed by our mortgage services business and at prices indexed to general marketrates. These commitments have terms of up to one year and can be renewed upon mutual agreement.
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HSBC Finance Corporation
Contractual Cash Obligations The following table summarizes our long-term contractual cash obligations atDecember 31, 2004 by period due:
2005 2006 2007 2008 2009 Thereafter Total
(in millions)
Principal balance of debt:
Time certiÑcates of deposit ÏÏÏÏÏÏÏÏÏÏ $ 2 $ - $ 10 $ - $ - $ - $ 12
Due to aÇliates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,485 1,241 624 - 2,030 2,409 13,789
Long term debt (includingsecured Ñnancings)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17,114 11,278 9,689 9,570 10,008 21,386 79,045
Total debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 24,601 12,519 10,323 9,570 12,038 23,795 92,846
(1) Expected beneÑt payments calculated include future service component.
These cash obligations could be funded primarily through cash collections on receivables, from the issuance ofnew unsecured debt or through secured Ñnancings of receivables. Our receivables and other liquid assetsgenerally have shorter lives than the liabilities used to fund them.
Our purchase obligations for goods and services at December 31, 2004 were not signiÑcant.
OÅ Balance Sheet Arrangements and Secured Financings
Securitizations and Secured Financings Securitizations (collateralized funding transactions structured toreceive sale treatment under Statement of Financial Accounting Standards No. 140, ""Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASBStatement No. 125,'' (""SFAS No. 140'')) and secured Ñnancings (collateralized funding transactions whichdo not receive sale treatment under SFAS No. 140) of consumer receivables have been a signiÑcant source offunding and liquidity for us. Securitizations and secured Ñnancings have been used to limit our reliance on theunsecured debt markets and often are more cost-eÅective than alternative funding sources.
In a securitization, a designated pool of non-real estate consumer receivables is removed from the balancesheet and transferred through a limited purpose Ñnancing subsidiary to an unaÇliated trust. This unaÇliatedtrust is a qualifying special purpose entity (""QSPE'') as deÑned by SFAS No. 140 and, therefore, is notconsolidated. The QSPE funds its receivable purchase through the issuance of securities to investors, entitlingthem to receive speciÑed cash Öows during the life of the securities. The receivables transferred to the QSPEserve as collateral for the securities. At the time of sale, an interest-only strip receivable is recorded,representing the present value of the cash Öows we expect to receive over the life of the securitized receivables,net of estimated credit losses and debt service. Under the terms of the securitizations, we receive annualservicing fees on the outstanding balance of the securitized receivables and the rights to future residual cashÖows on the sold receivables after the investors receive their contractual return. Cash Öows related to theinterest-only strip receivables and servicing the receivables are collected over the life of the underlyingsecuritized receivables.
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HSBC Finance Corporation
Certain securitization trusts, such as credit cards, are established at Ñxed levels and, due to the revolvingnature of the underlying receivables, require the sale of new receivables into the trust to replace runoÅ so thatthe principal dollar amount of the investors' interest remains unchanged. We refer to such activity asreplenishments. Once the revolving period ends, the amortization period begins and the trust distributesprincipal payments to the investors.
When loans are securitized in transactions structured as sales, we receive cash proceeds from investors, net oftransaction costs and expenses. These proceeds are generally used to re-pay other debt and corporateobligations and to fund new loans. The investors' shares of Ñnance charges and fees received from thesecuritized loans are collected each month and are primarily used to pay investors for interest and credit lossesand to pay us for servicing fees. We retain any excess cash Öow remaining after such payments are made toinvestors.
To help ensure that adequate funds are available to meet the cash needs of the QSPE, we may retain variousforms of interests in securitized assets through overcollateralization, subordinated series, residual interests orspread accounts which provide credit enhancement to investors. Overcollateralization is created when theunderlying receivables transferred to a QSPE exceed issued securities. The retention of a subordinated interestprovides additional assurance of payment to senior security holders. Residual interests are also referred to asinterest-only strip receivables and are rights to future cash Öows arising from the securitized receivables afterthe investors receive their contractual return. Spread accounts are cash accounts which are funded from initialdeposits from proceeds at the time of sale and/or from excess spread that would otherwise be returned to us.Investors and the securitization trusts have only limited recourse to our assets for failure of debtors to pay.That recourse is limited to our rights to future cash Öows and any other subordinated interest that we mayretain. Cash Öows related to the interest-only strip receivables and the servicing of receivables are collectedover the life of the underlying securitized receivables.
Our retained securitization interests are not in the form of securities and are included in receivables on ourconsolidated balance sheets. These retained interests were comprised of the following at December 31, 2004and 2003:
Other subordinated interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,809 4,107
Total retained securitization interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,183 $7,050
In a secured Ñnancing, a designated pool of receivables are conveyed to a wholly owned limited purposesubsidiary which in turn transfers the receivables to a trust which sells interests to investors. Repayment of thedebt issued by the trust is secured by the receivables transferred. The transactions are structured as securedÑnancings under SFAS No. 140. Therefore, the receivables and the underlying debt of the trust remain on ourbalance sheet. We do not recognize a gain in a secured Ñnancing transaction. Because the receivables and thedebt remain on our balance sheet, revenues and expenses are reported consistently with our owned balancesheet portfolio. Using this source of funding results in similar cash Öows as issuing debt through alternativefunding sources.
Under U.K. GAAP as currently reported by HSBC, securitizations are treated as secured Ñnancings. In orderto align our accounting treatment with that of HSBC under U.K. GAAP (and beginning in 2005 InternationalFinancial Reporting Standards), we began to structure all new collateralized funding transactions as securedÑnancings in the third quarter of 2004. However, because existing public MasterCard and Visa credit card
72
HSBC Finance Corporation
transactions were structured as sales to revolving trusts that require replenishments of receivables to supportpreviously issued securities, receivables will continue to be sold to these trusts and the resulting replenishmentgains recorded until the revolving periods end, the last of which is expected to occur in early 2008 based oncurrent projections. Private label trusts that publicly issue securities will now be replenished by HSBC BankUSA as a result of the daily sale of new domestic private label receivable originations to HSBC Bank USA.We will continue to replenish at reduced levels, certain non-public personal non-credit card and MasterCard/Visa securities issued to conduits and record the resulting replenishment gains for a period of time in order tomanage liquidity. Since our securitized receivables have varying lives, it will take several years for thesereceivables to pay-oÅ and the related interest-only strip receivables to be reduced to zero. The termination ofsale treatment on new collateralized funding activity reduced our reported net income under U.S. GAAP.There was no impact, however, on cash received from operations or on U.K. GAAP reported results.
Securitizations and secured Ñnancings were as follows:
Year ended December 31,
2004 2003 2002
(in millions)
Initial Securitizations:
Auto Ñnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ 1,523 $ 3,289
Personal non-credit cardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 828 675 325
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $30,310 $30,875 $26,124
Secured Ñnancings:
Real estate securedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,299 $ 3,260 $ 7,549
Auto Ñnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,790 - -
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,089 $ 3,260 $ 7,549
Our securitization and secured Ñnancing activity in 2002 exceeded that of both 2004 and 2003. The lowerlevels in 2004 and 2003 reÖected the use of additional sources of liquidity provided by HSBC and itssubsidiaries and the decision in the third quarter of 2004 to structure all new collateralized fundingtransactions as secured Ñnancings.
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HSBC Finance Corporation
Outstanding securitized receivables consisted of the following:
At December 31,
2004 2003
(in millions)
Real estate secured ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 81 $ 194
Auto Ñnance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,679 4,675
Personal non-credit cardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,773 884 225 - 3,882
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $9,030 $3,902 $960 $333 $14,225
At December 31, 2004, the expected weighted-average remaining life of these transactions was .96 years.
The securities issued with our securitizations may pay oÅ sooner than originally scheduled if certain eventsoccur. For certain auto securitizations, early payoÅ of securities may occur if established delinquency or losslevels are exceeded. For all other securitizations, early payoÅ of the securities begins if the annualized portfolioyield drops below a base rate or if certain other events occur. We do not presently believe that any early payoÅwill take place. If early payoÅ occurred, our funding requirements would increase. These additionalrequirements could be met through secured Ñnancings, issuance of various types of debt or borrowings underexisting back-up lines of credit. We believe we would continue to have adequate sources of funds if an earlypayoÅ event occurred.
At December 31, 2004, securitizations structured as sales represented 12 percent and secured Ñnancingsrepresented 6 percent of the funding associated with our managed funding portfolio. At December 31, 2003,securitizations structured as sales represented 21 percent and secured Ñnancings represented 5 percent of thefunding associated with our managed funding portfolio. The 2003 balances include the balances of thedomestic private label receivable portfolio which was sold in December 2004.
We continue to believe the market for securities backed by receivables is a reliable, eÇcient and cost-eÅectivesource of funds, and we will continue to use secured Ñnancings of consumer receivables as a source of ourfunding and liquidity. However, if the market for securities backed by receivables were to change, we may beunable to enter into new secured Ñnancings or to do so at favorable pricing levels. Factors aÅecting our abilityto structure collateralized funding transactions as secured Ñnancings or to do so at cost-eÅective rates includethe overall credit quality of our securitized loans, the stability of the securitization markets, the securitizationmarket's view of our desirability as an investment, and the legal, regulatory, accounting and tax environmentsgoverning securitized transactions.
At December 31, 2004, we had domestic facilities with commercial and investment banks under which wemay use up to $14.1 billion of our receivables in collateralized funding transactions structured either assecuritizations or secured Ñnancings. The facilities are renewable at the banks' option. At December 31, 2004,
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HSBC Finance Corporation
$8.2 billion of auto Ñnance, MasterCard and Visa and personal non-credit card receivables and $1.7 billion ofreal estate secured receivables were used in collateralized funding transactions structured either as securitiza-tions or secured Ñnancings under these funding programs. In addition, we have available a $4 billion singleseller mortgage facility (none of which was outstanding at December 31, 2004) structured as a securedÑnancing. At December 31, 2004, the U.K. had approximately $170 million in receivables securitized underformer conduit lines which have not been renewed as a result of funding available from HSBC. As previouslydiscussed, beginning in the third quarter of 2004, we decided to fund all new collateralized fundingtransactions as secured Ñnancings to align our accounting treatment with that of HSBC under U.K. GAAP(and beginning in 2005 International Financial Reporting Standards). The amount available under thefacilities will vary based on the timing and volume of collateralized funding transactions. Through existingterm bank Ñnancing and new debt issuances, we believe we should continue to have adequate sources of funds,which could be impacted from time to time by volatility in the Ñnancial markets or if one or more of thesefacilities were unable to be renewed.
Risk Management
Our activities involve analysis, evaluation, acceptance and management of some degree of risk or combinationof risks. Accordingly, we have comprehensive risk management policies to address potential Ñnancial risks,which include credit risk, liquidity risk, market risk (which includes interest rate and foreign currencyexchange risks), and operational risk. Our risk management policy is designed to identify and analyze theserisks, to set appropriate limits and controls, and to monitor the risks and limits continually by means of reliableand up-to-date administrative and information systems. We continually modify and enhance our riskmanagement policies and systems to reÖect changes in markets and products and in best practice riskmanagement processes. Our risk management policies are primarily carried out in accordance with practiceand limits set by the HSBC Group Management Board. The HSBC Finance Corporation Asset LiabilityCommittee (""ALCO'') meets regularly to review risks and approve appropriate risk management strategieswithin the limits established by the HSBC Group Management Board and HSBC Finance Corporation'sBoard of Directors.
Credit Risk Management Credit risk is the risk that Ñnancial loss arises from the failure of a customer orcounterparty to meet its obligations under a contract. Our credit risk arises primarily from lending and treasuryactivities.
We have established detailed policies to address the credit risk that arises from our lending activities. Ourcredit and portfolio management procedures focus on risk-based pricing and eÅective collection and customeraccount management eÅorts for each loan. Our lending guidelines, which delineate the credit risk we arewilling to take and the related terms, are speciÑc not only for each product, but also take into considerationvarious other factors including the regional economic conditions. We also have speciÑc policies to ensure theestablishment of appropriate credit loss reserves on a timely basis to cover probable losses of principal, interestand fees. See ""Credit Quality'' for a detailed description of our policies regarding the establishment of creditloss reserves, our delinquency and charge-oÅ policies and practices and our customer account managementpolicies and practices. While we develop our own policies and procedures for all of our lending activities, theyare based on standards established by HSBC and are regularly reviewed and updated both on a HSBCFinance Corporation and HSBC level.
Counterparty credit risk is our primary exposure on our interest rate swap portfolio. Counterparty credit risk isthe risk that the counterparty to a transaction fails to perform according to the terms of the contract. Wecontrol counterparty credit risk in derivative instruments through established credit approvals, risk controllimits, collateral, and ongoing monitoring procedures. Counterparty limits have been set and are closelymonitored as part of the overall risk management process and contract structure. During the third quarter of2003 and continuing through 2004, we utilize an aÇliate, HSBC Bank USA, as the primary provider of newdomestic derivative products. We have never suÅered a loss due to counterparty failure.
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HSBC Finance Corporation
Currently the majority of our existing derivative contracts are with HSBC subsidiaries, making them ourprimary counterparty in derivative transactions. Most swap agreements, both with unaÇliated and aÇliatedthird parties, require that payments be made to, or received from, the counterparty when the fair value of theagreement reaches a certain level. Generally, third-party swap counterparties provide collateral in the form ofcash which is recorded in our balance sheet as other assets or derivative related liabilities and totaled$.4 billion at December 31, 2004 and $.4 billion at December 31, 2003. AÇliate swap counterparties generallyprovide collateral in the form of securities which are not recorded on our balance sheet and totaled $2.2 billionat December 31, 2004 and $.5 billion at December 31, 2003. At December 31, 2004, we had derivativecontracts with a notional value of approximately $71.6 billion, including $61.3 billion outstanding with HSBCBank USA. At December 31, 2003, we had derivative contracts with a notional value of approximately$68 billion, including $40 billion outstanding with HSBC Bank USA.
See Note 16 to the accompanying consolidated Ñnancial statements, ""Derivative Financial Instruments,'' foradditional information related to interest rate risk management and Note 25, ""Fair Value of FinancialInstruments,'' for information regarding the fair value of certain Ñnancial instruments.
Liquidity Risk The management of liquidity risk is addressed in HSBC Finance Corporation's fundingmanagement policies and practices. HSBC Finance Corporation funds itself principally through unsecuredterm funding in the markets, through securitizations and secured Ñnancing transactions and throughborrowings from HSBC and HSBC clients. Generally, the lives of our assets are shorter than the lives of theliabilities used to fund them. This initially reduces liquidity risk by ensuring that funds are received prior toliabilities becoming due.
Our ability to ensure continuous access to the capital markets and maintain a diversiÑed funding base isimportant in meeting our funding needs. To manage this liquidity risk, we oÅer a broad line of debt productsdesigned to meet the needs of both institutional and retail investors. We maintain investor diversity by placingdebt directly with customers, through selected dealer programs and by targeted issuance of large liquidtransactions. Through collateralized funding transactions, we are able to access an alternative investor baseand further diversify our funding strategies. We also maintain a comprehensive, direct marketing program toensure our investors receive consistent and timely information regarding our Ñnancial performance.
The measurement and management of liquidity risk is a primary focus. Three standard analyses are utilized toaccomplish this goal. First, a rolling 60 day funding plan is updated daily to quantify near-term needs anddevelop the appropriate strategies to fund those needs. As part of this process, debt maturity proÑles (daily,monthly, annually) are generated to assist in planning and limiting any potential rollover risk (which is the riskthat we will be unable to pay our debt or borrow additional funds as it becomes due). Second, comprehensiveplans identifying monthly funding requirements for the next twelve months are updated at least weekly andmonthly funding plans for the next two years are maintained. These plans focus on funding projected assetgrowth and drive both the timing and size of debt issuances. And third, a Maximum Cumulative OutÖow(MCO) analysis is updated regularly to measure liquidity risk. Cumulative comprehensive cash inÖows aresubtracted from outÖows to generate a net exposure that is tracked both monthly over the next 12 monthperiod and annually for 5 years. Net outÖow limits are reviewed by HSBC Finance Corporation's ALCO andHSBC.
We recognize the importance of being prepared for constrained funding environments. While the potentialscenarios driving this analysis have changed due to our aÇliation with HSBC, contingency funding plans arestill maintained as part of the liquidity management process. Alternative funding strategies are updatedregularly for a rolling 12 months and assume limited access to unsecured funding and continued access to thecollateralized funding markets. These alternative strategies are designed to enable us to achieve monthlyfunding goals through controlled growth, sales of receivables and access to committed sources of contingentliquidity including bank lines and undrawn securitization conduits. Although our overall liquidity situation hasimproved signiÑcantly since our acquisition by HSBC, the strategies and analyses utilized in the past tosuccessfully manage liquidity remain in place today. The combination of this process with the funding
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HSBC Finance Corporation
provided by HSBC subsidiaries and clients should ensure our access to diverse markets, investor bases andadequate funding for the foreseeable future.
See ""Liquidity and Capital Resources'' for further discussion of our liquidity position.
Market Risk The objective of our market risk management process is to manage and control market riskexposures in order to optimize return while maintaining a market proÑle as a provider of Ñnancial products andservices. Market risk is the risk that movements in market rates, including interest rates and foreign currencyexchange rates, will reduce our income or the value of our portfolios.
Future net interest income is aÅected by movements in interest rates. Although our main operations are in theU.S., we also have operations in Canada and the U.K. which prepare their Ñnancial statements in their localcurrency. Accordingly, our Ñnancial statements are aÅected by movements in exchange rates between thefunctional currencies of these subsidiaries and the U.S. dollar. We maintain an overall risk managementstrategy that uses a variety of interest rate and currency derivative Ñnancial instruments to mitigate ourexposure to Öuctuations caused by changes in interest rates and currency exchange rates. We manage ourexposure to interest rate risk primarily through the use of interest rate swaps, but also use forwards, futures,options, and other risk management instruments. We manage our exposure to foreign currency exchange riskprimarily through the use of currency swaps, options and forwards. We do not use leveraged derivativeÑnancial instruments for interest rate risk management. Since our acquisition by HSBC, we have not enteredinto foreign exchange contracts to hedge our investment in foreign subsidiaries.
Prior to the acquisition by HSBC, the majority of our fair value and cash Öow hedges were eÅective hedgeswhich qualiÑed for shortcut accounting under SFAS 133. Under the Financial Accounting Standards Board'sinterpretations of SFAS 133, the shortcut method of accounting was no longer allowed for interest rate swapswhich were outstanding at the time of the merger. As a consequence of the acquisition, pre-existing hedgingrelationships, including hedging relationships that had previously qualiÑed under the ""shortcut'' method ofaccounting pursuant to SFAS 133, were required to be reestablished. In the fourth quarter of 2004,management determined that there were some deÑciencies in the documentation required to support hedgeaccounting under U.S. GAAP.
Management, having determined during the fourth quarter of 2004 that there were certain documentationdeÑciencies, engaged independent expert consultants to advise on the continuing eÅectiveness of the identiÑedhedging relationships and consulted with our independent accountants, KPMG LLP. As a result of thisassessment, we concluded that a substantial number of our hedges met the correlation eÅectivenessrequirement of SFAS 133 throughout the period following our acquisition by HSBC. However, we alsodetermined in conjunction with KPMG LLP that, although a substantial number of the impacted hedgessatisÑed the correlation eÅectiveness requirement of SFAS 133, there were technical deÑciencies in thedocumentation that could not be corrected retroactively or disregarded notwithstanding the proven eÅective-ness of the hedging relationship in place and, consequently, that the requirements of SFAS 133 were not metand that hedge accounting was not appropriate during the period these documentation deÑciencies existed.Substantially all derivative Ñnancial instruments we have entered into subsequent to the acquisition qualify aseÅective hedges under SFAS 133. The discontinuation of hedge accounting on our fair value and cash Öowhedging instruments outstanding at the time of the merger, coupled with the loss of hedge accounting oncertain post merger fair value swaps, collectively increased net income by $175 million in 2004 and decreasednet income by $62 million for the period March 29, 2003 through December 31, 2003.
Interest rate risk is deÑned as the impact of changes in market interest rates on our earnings. We usesimulation models to measure the impact of changes in interest rates on net interest income. The keyassumptions used in these models include expected loan payoÅ rates, loan volumes and pricing, cash Öowsfrom derivative Ñnancial instruments and changes in market conditions. These assumptions are based on ourbest estimates of actual conditions. The models cannot precisely predict the actual impact of changes ininterest rates on our earnings because these assumptions are highly uncertain. At December 31, 2004, ourinterest rate risk levels were below those allowed by our existing policy.
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HSBC Finance Corporation
We generally fund our assets with liabilities that have similar interest rate features, or are combined atissuance with derivatives such that they are similar, but diÅerent maturities. This initially reduces interest raterisk. Over time, however, customer demand for our receivable products shifts between Ñxed rate and Öoatingrate products, based on market conditions and preferences. These shifts in loan products produce diÅerentinterest rate risk exposures. We use derivative Ñnancial instruments, principally interest rate swaps, to managethese exposures. Interest rate futures, interest rate forwards and purchased options are also used on a limitedbasis to reduce interest rate risk.
We monitor the impact that an immediate hypothetical 100 basis points parallel increase or decrease ininterest rates would have on our net interest income over the next twelve months. The following tablesummarizes such estimated impact:
AtDecember 31,
2004 2003
(Restated)(in millions)
Decrease in net interest income following an immediate hypothetical 100 basis pointsparallel rise in interest ratesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $279 $383
Increase in net interest income following an immediate hypothetical 100 basis pointsparallel fall in interest rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $274 $396
These estimates include both the net interest income impact of the derivative positions we have entered intowhich are considered to be eÅective hedges under SFAS 133 and the impact of economic hedges of certainunderlying debt instruments which do not qualify for hedge accounting as previously discussed, as if they wereeÅective hedges under SFAS 133. These estimates also assume we would not take any corrective actions inresponse to interest rate movements and, therefore, exceed what most likely would occur if rates were tochange by the amount indicated.
Net interest income at risk will change as a result of the loss of hedge accounting on a portfolio of economichedges. At December 31, 2004, our net interest income sensitivity to a 100 basis points immediate rise in ratesfor the next 12 months is a decrease of $285 million as opposed to the amount reported above, and thesensitivity to an immediate 100 basis points fall in rates for the next 12 months is an increase of $286 millionas opposed to the amount reported above. This sensitivity only considers changes in interest rates and does notconsider changes from other variables, such as exchange rates that may impact margin. The increase inexposure to rising interest rates results primarily from the reclassiÑcation of cash Öow hedges (the payÑxed/receive Öoating interest rate swaps), which do not qualify for hedge accounting under SFAS 133. It isour intention to reduce this exposure by regaining hedge accounting treatment as soon as possible. We willcontinue to manage our total interest rate risk on a basis consistent with the risk management processemployed since the acquisition.
HSBC Group also has certain limits and benchmarks that serve as guidelines in determining the appropriatelevels of interest rate risk. One such limit is expressed in terms of the Present Value of a Basis Point(""PVBP''), which reÖects the change in value of the balance sheet for a one basis point movement in allinterest rates. Our PVBP limit as of December 31, 2004 was $3 million, which includes limits associated withhedging instruments. Thus, for a one basis point change in interest rates, the policy dictates that the value ofthe balance sheet shall not increase or decrease by more than $3 million. As of December 31, 2004, we had aPVBP position of less than $1 million reÖecting the impact of a one basis point increase in interest rates.
While the total PVBP position will not change as a result of the loss of hedge accounting, the portfolio ofineÅective hedges at December 31, 2004 represent PVBP risk of ($2.7) million. The interest rate riskremaining for all other assets and liabilities, including eÅective hedges, results in an oÅsetting PVBP risk of$1.9 million and, therefore, a net PVBP position of less than $1 million.
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HSBC Finance Corporation
Foreign currency exchange risk refers to the potential changes in current and future earnings or capital arisingfrom movements in foreign exchange rates. We enter into foreign exchange rate forward contracts andcurrency swaps to minimize currency risk associated with changes in the value of foreign-denominatedliabilities. Currency swaps convert principal and interest payments on debt issued from one currency toanother. For example, we may issue Euro-denominated debt and then execute a currency swap to convert theobligation to U.S. dollars. Prior to the acquisition, we had periodically entered into foreign exchange contractsto hedge portions of our investments in our United Kingdom and Canada subsidiaries. We estimate that a10 percent adverse change in the British pound/U.S. dollar and Canadian dollar/U.S. dollar exchange ratewould result in a decrease in common shareholder's(s') equity of $188 million at December 31, 2004 and$162 million at December 31, 2003 and would not have a material impact on net income.
We have issued debt in a variety of currencies and simultaneously executed currency swaps to hedge thefuture interest and principal payments. As a result of the loss of hedge accounting on currency swapsoutstanding at the time of merger, the recognition of the change in the currency risk on these swaps isrecorded diÅerently than the corresponding risk on the underlying foreign denominated debt. Currency risk onthe swap is now recognized immediately on the net present value of all future swap payments. On thecorresponding debt, currency risk is recognized on the principal outstanding which is converted at the periodend spot translation rate and on the interest accrual which is converted at the average spot rate for thereporting period.
Operational Risk Operational risk is the risk of loss arising through fraud, unauthorized activities, error,omission, ineÇciency, systems failure or from external events. It is inherent in every business organization andcovers a wide spectrum of issues. We manage this risk through a controls-based environment in whichprocesses are documented, authorization is independent and transactions are reconciled and monitored. This issupported by an independent program of periodic reviews undertaken by Internal Audit. We also monitorexternal operations risk events which take place in the Ñnancial services industry to ensure that we remain inline with best practice and take account of lessons learned from publicized operational failures within theÑnancial services industry. We also maintain and test emergency policies and procedures to support operationsand our personnel in the event of disasters.
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HSBC Finance Corporation
GLOSSARY OF TERMS
AÇnity Credit Card Ó A MasterCard or Visa account jointly sponsored by the issuer of the card and anorganization whose members share a common interest (e.g., the AFL-CIO Union Plus» credit card program).
Auto Finance Loans Ó Closed-end loans secured by a Ñrst or second lien on a vehicle.
Co-Branded Credit Card Ó A MasterCard or Visa account that is jointly sponsored by the issuer of the cardand another corporation (e.g., the GM Card»). The account holder typically receives some form of addedbeneÑt for using the card.
Consumer Net Charge-oÅ Ratio Ó Net charge-oÅs of consumer receivables divided by average consumerreceivables outstanding.
Contractual Delinquency Ó A method of determining aging of past due accounts based on the status ofpayments under the loan. Delinquency status may be aÅected by customer account management policies andpractices such as the restructure of accounts, forbearance agreements, extended payment plans, modiÑcationarrangements, external debt management plans, loan rewrites and deferments.
EÇciency Ratio Ó Ratio of total costs and expenses less policyholders' beneÑts to net interest income and otherrevenues less policyholders' beneÑts.
Fee Income Ó Income associated with interchange on credit cards and late and other fees from the originationor acquisition of loans.
Foreign Exchange Contract Ó A contract used to minimize our exposure to changes in foreign currencyexchange rates.
Futures Contract Ó An exchange-traded contract to buy or sell a stated amount of a Ñnancial instrument orindex at a speciÑed future date and price.
HINO Ó HSBC Investments (North America) Inc., which is the immediate parent of HSBC FinanceCorporation.
HNAH Ó HSBC North America Holdings Inc. and the immediate parent of HINO.
HSBC Ó HSBC Holdings plc.
HSBC Bank USA Ó HSBC Bank USA, National Association
HTSU Ó HSBC Technology and Services (USA) Inc., which provides information technology services to allsubsidiaries of HNAH and other subsidiaries of HSBC.
Goodwill Ó Represents the purchase price over the fair value of identiÑable assets acquired less liabilitiesassumed from business combinations.
Intangible Assets Ó Assets (not including Ñnancial assets) that lack physical substance. Our acquiredintangibles include purchased credit card relationships and related programs, merchant relationships in ourretail services business, other loan related relationships, trade names, and technology, customer lists and othercontracts.
Interchange Fees Ó Fees received for processing a credit card transaction through the MasterCard or Visanetwork.
Interest-only Strip Receivables Ó Represent our contractual right to receive interest and other cash Öows fromour securitization trusts after the investors receive their contractual return.
Interest Rate Swap Ó Contract between two parties to exchange interest payments on a stated principalamount (notional principal) for a speciÑed period. Typically, one party makes Ñxed rate payments, while theother party makes payments using a variable rate.
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HSBC Finance Corporation
LIBOR Ó London Interbank OÅered Rate. A widely quoted market rate which is frequently the index usedto determine the rate at which we borrow funds.
Liquidity Ó A measure of how quickly we can convert assets to cash or raise additional cash by issuing debt.
Managed Basis Ó A non-GAAP method of reporting whereby net interest income, other revenues and creditlosses on securitized receivables structured as sales are reported as if those receivables were still held on ourbalance sheet.
Managed Receivables Ó The sum of receivables on our balance sheet and those that we service for investors aspart of our asset securitization program.
MasterCard and Visa Receivables Ó Receivables generated through customer usage of MasterCard and Visacredit cards.
Net Interest Income Ó Interest income from receivables and noninsurance investment securities reduced byinterest expense.
Net Interest Margin Ó Net interest income as a percentage of average interest-earning assets.
Nonaccrual Loans Ó Loans on which we no longer accrue interest because ultimate collection is unlikely.
Options Ó A contract giving the owner the right, but not the obligation, to buy or sell a speciÑed item at a Ñxedprice for a speciÑed period.
Owned Receivables Ó Receivables held on our balance sheet.
Personal Homeowner Loan (""PHL'') Ó A high loan-to-value real estate loan that has been underwritten andpriced as an unsecured loan. These loans are reported as personal non-credit card receivables.
Personal Non-Credit Card Receivables Ó Unsecured lines of credit or closed-end loans made to individuals.
Portfolio Seasoning Ó Relates to the aging of origination vintages. Loss patterns emerge slowly over time asnew accounts are booked.
Private Label Credit Card Ó A line of credit made available to customers of retail merchants evidenced by acredit card bearing the merchant's name.
Product Vintage Analysis Ó Refers to loss curves on speciÑc product origination pools by date of origination.
Real Estate Secured Loan Ó Closed-end loans and revolving lines of credit secured by Ñrst or second liens onresidential real estate.
Receivables Serviced with Limited Recourse Ó Receivables we have securitized in transactions structured assales and for which we have some level of potential loss if defaults occur.
Return on Average Common Shareholder's(s') Equity Ó Net income less dividends on preferred stock dividedby average common shareholder's(s') equity.
Return on Average Managed Assets Ó Net income divided by average managed assets.
Return on Average Owned Assets Ó Net income divided by average owned assets.
Secured Financing Ó The process where interests in a dedicated pool of Ñnancial assets are sold to investors.Generally, the receivables are transferred through a limited purpose Ñnancing subsidiary to a trust that issuesinterests that are sold to investors. These transactions do not receive sale treatment under SFAS No. 140. Thereceivables and related debt remain on our balance sheet.
Securitization Ó The process where interests in a dedicated pool of Ñnancial assets, typically credit card, autoor personal non-credit card receivables, are sold to investors. Generally, the receivables are sold to a trust that
81
HSBC Finance Corporation
issues interests that are sold to investors. These transactions are structured to receive sale treatment underSFAS No. 140. The receivables are then removed from our balance sheet.
Securitization Revenue Ó Includes income associated with current and prior period securitizations structuredas sales of receivables with limited recourse. Such income includes gains on sales, net of our estimate ofprobable credit losses under the recourse provisions, servicing income and excess spread relating to thosereceivables.
Tangible Common Equity Ó Common shareholder's(s') equity (excluding unrealized gains and losses oninvestments and cash Öow hedging instruments and any minimum pension liability) less acquired intangiblesand goodwill.
Tangible Shareholder's(s') Equity Ó Tangible common equity, preferred stock, company obligatedmandatorily redeemable preferred securities of subsidiary trusts (including amounts due to aÇliates) andsenior debt which contains mandatorily redeemable obligations to purchase HSBC common stock in 2006(the Adjustable Conversion-Rate Equity Security Units), adjusted for purchase accounting adjustments.
Tangible Managed Assets Ó Total managed assets less acquired intangibles, goodwill and derivative Ñnancialassets.
Taxpayer Financial Services (""TFS'') Income Ó Our taxpayer Ñnancial services business provides consumertax refund lending in the United States. This income primarily consists of fees received from the consumer fororigination of a short term loan which will be repaid from their federal income tax return refund.
Whole Loan Sales Ó Sales of loans to third parties without recourse. Typically, these sales are made pursuantto our liquidity or capital management plans.
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 608 $1,215 $1,173 $1,060 $ 860
(1) These non-GAAP Ñnancial measures are provided for comparison of our operating trends and should be read in conjunction with our
owned basis GAAP Ñnancial information. Refer to ""Reconciliations to GAAP Financial Measures'' for a discussion of non-GAAP
Ñnancial information and for quantitative reconciliations to the equivalent GAAP basis Ñnancial measure.(2) The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios in December 2004 increased
private label net charge-oÅs by $197 million (112 basis points) and MasterCard/Visa net charge-oÅs by $5 million (2 basis points)
and total consumer net charge-oÅs by $202 million (17 basis points) for the year ended December 31, 2004.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY Ó OWNED RECEIVABLES
2004 2003 2002 2001 2000
(dollars are in millions)
Total Owned Credit Loss Reserves at January 1ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,793 $ 3,333 $ 2,663 $ 2,112 $ 1,757
Provision for Credit LossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,334 3,967 3,732 2,913 2,117
(1) These non-GAAP Ñnancial measures are provided for comparison of our operating trends and should be read in conjunction with ourowned basis GAAP Ñnancial information. Refer to ""Reconciliations to GAAP Financial Measures'' for a discussion of non-GAAPÑnancial information and for quantitative reconciliations to the equivalent GAAP basis Ñnancial measure.
(2) Includes $5 million of MasterCard and Visa and $197 million of private label charge-oÅ relating to the adoption of FFIEC charge-oÅpolicies in December 2004.
(3) As previously discussed, the adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios andsubsequent sale of the domestic private label receivable portfolio in December 2004 had a signiÑcant impact on this ratio. Reserves asa percentage of net charge-oÅs excluding domestic private label net charge-oÅs and charge-oÅ relating to the adoption of FFIEC was96.0% at December 31, 2004.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN Ó 2004 COMPARED TO 2003 (OWNED BASIS)
Finance and InterestIncome/Interest Increase/(Decrease) Due to:
(1) Nonaccrual loans are included in average outstanding balances.(2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest
variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on therelative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of theindividual components.
(3) Represents net interest income as a percent of average interest-earning assets(4) Represents the diÅerence between the yield earned on interest-earning assets and the cost of the debt used to fund the assets(5) The net interest margin analysis includes the following for foreign businesses:
(1) Nonaccrual loans are included in average outstanding balances.(2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest
variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on therelative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of theindividual components
(3) Represents net interest income as a percent of average interest-earning assets(4) Represents the diÅerence between the yield earned on interest-earning assets and the cost of the debt used to fund the assets(5) The net interest income analysis includes the following for foreign businesses:
2003 2002
Average interest-earning assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,779 $6,616
Average interest-bearing liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7,957 6,076
Net interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 660 483
Net interest margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.5% 7.3%(6) Average rate does not recompute from dollar Ñgures presented due to rounding.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
NET INTEREST MARGIN Ó 2004 COMPARED TO 2003 AND 2002 (MANAGED BASIS)
Net Interest Margin on a Managed Basis As receivables are securitized rather than held in our portfolio, net interest margin is reclassiÑed tosecuritization revenue. We retain a substantial portion of the proÑt inherent in the receivables while increasing liquidity. The comparability of net interestmargin between periods may be impacted by the level and type of receivables securitized. Net interest margin on a managed basis includes Ñnance incomeearned on our owned receivables as well on our securitized receivables. This Ñnance income is oÅset by interest expense on the debt recorded on ourbalance sheet as well as the contractual rate of return on the instruments issued to investors when the receivables were securitized.
Increase/(Decrease) Due to:
Finance and Interest 2004 Compared to 2003 2003 Compared to 2002Average Outstanding
Interest Spread Ó Managed Basis(4)ÏÏÏ 7.8% 8.3% 8.3%
(1) Nonaccrual loans are included in average outstanding balances.(2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest variance. For total receivables, total interest-earning
assets and total debt, the rate and volume variances are calculated based on the relative weighting of the individual components comprising these totals. These totals do not represent an
arithmetic sum of the individual components(3) Represents net interest income as a percent of average interest-earning assets(4) Represents the diÅerence between the yield earned on interest-earning assets and cost of the debt used to fund the assets.(5) Average rate does not recompute from dollar Ñgures presented due to rounding.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
Our consolidated Ñnancial statements are prepared in accordance with accounting principles generallyaccepted in the United States (""GAAP''). In addition to the GAAP Ñnancial results reported in ourconsolidated Ñnancial statements, MD&A includes reference to the following information which is presentedon a non-GAAP basis:
Operating Results, Percentages and Ratios Certain percentages and ratios have been presented on anoperating basis and have been calculated using ""operating net income'', a non-GAAP Ñnancial measure.""Operating net income'' is net income excluding certain nonrecurring items. These nonrecurring items are alsoexcluded in calculating our operating basis eÇciency ratios. We believe that excluding these items helpsreaders of our Ñnancial statements to understand better the results and trends of our underlying business.
Managed Basis Reporting We monitor our operations and evaluate trends on a managed basis (a non-GAAPÑnancial measure), which assumes that securitized receivables have not been sold and are still on our balancesheet. We manage and evaluate our operations on a managed basis because the receivables that we securitizeare subjected to underwriting standards comparable to our owned portfolio, are serviced by operatingpersonnel without regard to ownership and result in a similar credit loss exposure for us. In addition, we fundour operations, review our operating results, and make decisions about allocating resources such as employeesand capital on a managed basis.
When reporting on a managed basis, net interest margin, provision for credit losses and fee income related toreceivables securitized are reclassiÑed from securitization revenue in our owned statements of income into theappropriate caption. Additionally, charge-oÅ and delinquency associated with these receivables are included inour managed basis credit quality statistics.
Debt analysts, rating agencies and others also evaluate our operations on a managed basis for the reasonsdiscussed above and have historically requested managed basis information from us. We believe that managedbasis information enables investors and other interested parties to better understand the performance andquality of our entire managed loan portfolio and is important to understanding the quality of originations andthe related credit risk inherent in our owned portfolio.
Equity Ratios Tangible shareholder's(s') equity to tangible managed assets (""TETMA''), tangible share-holder's(s') equity plus owned loss reserves to tangible managed assets (""TETMA ° Owned Reserves'') andtangible common equity to tangible managed assets are non-GAAP Ñnancial measures that are used by HSBCFinance Corporation management or certain rating agencies to evaluate capital adequacy. These ratios maydiÅer from similarly named measures presented by other companies. The most directly comparable GAAPÑnancial measure is common and preferred equity to owned assets.
We and certain rating agencies also monitor our equity ratios excluding the impact of purchase accountingadjustments. We do so because we believe that the purchase accounting adjustments represent non-cashtransactions which do not aÅect our business operations, cash Öows or ability to meet our debt obligations.
Preferred securities issued by certain non-consolidated trusts are considered equity in the TETMA andTETMA ° Owned Reserves calculations because of their long-term subordinated nature and the ability todefer dividends. Our Adjustable Conversion-Rate Equity Security Units, which exclude purchase accountingadjustments, are also considered equity in these calculations because they include investor obligations topurchase HSBC ordinary shares in 2006.
Quantitative Reconciliations of Non-GAAP Financial Measures to GAAP Financial Measures For a reconcil-iation of managed basis net interest income, fee income and provision for credit losses to the comparableowned basis amounts, see Note 23, ""Business Segments,'' to the accompanying consolidated Ñnancialstatements. For a reconciliation of our owned loan portfolio by product to our managed loan portfolio, seeNote 7, ""Receivables,'' to the accompanying consolidated Ñnancial statements. Reconciliations of our ownedbasis and managed basis credit quality, loss reserves, net interest income, selected Ñnancial ratios, includingoperating ratios, and our equity ratios follow.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS Ó 2004Two-Months-and-Over Contractual Delinquency
Year-to-Date Charge-oÅs,Two-Months- Two-Months- Net of Recoveries
and-Over and-OverContractual Receivables Contractual Net Average NetDelinquency Outstanding Delinquency
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $5,121 $121,080 4.23% $5,674 $123,487 4.59%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.(2) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.
Serviced withOwned Limited Recourse Managed
(dollars are in millions)Nonaccrual ReceivablesDomestic:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,008 546 3,554Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4 - 4
Real Estate Charge-oÅs and REO Expense as a Percent of Average Real Estate SecuredReceivables
Real estate charge-oÅs and REO expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 779 $ 2 $ 781Average real estate secured receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 56,303 159 56,462
Real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.38% 1.26% 1.38%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS Ó 2003Two-Months-and-Over Contractual Delinquency
Two-Months- Two-Months- Year-to-Date Charge-oÅs, Net of Recoveriesand-Over and-Over
Contractual Receivables Contractual Net Average NetDelinquency Outstanding Delinquency
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,368 $118,579 5.37% $5,254 $112,801 4.66%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.(2) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.
Serviced withOwned Limited Recourse Managed
(dollars are in millions)Nonaccrual ReceivablesDomestic:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,138 865 4,003Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 - 6
Real Estate Charge-oÅs and REO Expense as a Percent of Average Real Estate SecuredReceivables
Real estate charge-oÅs and REO expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 708 $ 5 $ 713Average real estate secured receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 49,852 272 50,124
Real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.42% 1.69% 1.42%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.
92
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS Ó 2002Two-Months-and-Over Contractual Delinquency
Year-to-Date Charge-oÅs,Two-Months- Two-Months- Net of Recoveries
and-Over and-OverContractual Receivables Contractual Net Average NetDelinquency Outstanding Delinquency
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.(2) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.
Serviced withOwned Limited Recourse Managed
(dollars are in millions)Nonaccrual ReceivablesDomestic:
Total consumerÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,651 681 3,332Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 - 15
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,666 $681 $ 3,347
Accruing Consumer Receivables 90 or More Days DelinquentDomestic:
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 861 $312 $ 1,173
Real Estate Charge-oÅs and REO Expense as a Percent of Average Real Estate SecuredReceivables
Real estate charge-oÅs and REO expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 608 $ 7 $ 615Average real estate secured receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47,258 572 47,830
Real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.29% 1.28% 1.29%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.
93
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS Ó 2001Two-Months-and-Over Contractual Delinquency
Year-to-Date Charge-oÅs,Two-Months- Two-Months- Net of Recoveries
and-Over and-OverContractual Receivables Contractual Net Average NetDelinquency Outstanding Delinquency
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.(2) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.
Serviced withOwned Limited Recourse Managed
(dollars are in millions)Nonaccrual ReceivablesDomestic:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,012 539 2,551Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 15 - 15
Real Estate Charge-oÅs and REO Expense as a Percent of Average Real Estate SecuredReceivables
Real estate charge-oÅs and REO expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 326 $ 8 $ 334Average real estate secured receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 38,850 1,199 40,049
Real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .84% .70% .83%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.
94
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
CREDIT QUALITY STATISTICS Ó 2000Two-Months-and-Over Contractual Delinquency
Year-to-Date Charge-oÅs,Two-Months- Two-Months- Net of Recoveries
and-Over and-OverContractual Receivables Contractual Net Average NetDelinquency Outstanding Delinquency
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.(2) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.
Serviced withOwned Limited Recourse Managed
(dollars are in millions)Nonaccrual ReceivablesDomestic:
Total consumerÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,615 455 2,070Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 42 - 42
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,657 $ 455 $ 2,112
Accruing Consumer Receivables 90 or More Days DelinquentDomestic:
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 649 $ 211 $ 860
Real Estate Charge-oÅs and REO Expense as a Percent of Average Real Estate SecuredReceivables
Real estate charge-oÅs and REO expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 214 $ 16 $ 230Average real estate secured receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,682 1,848 32,530
Real estate charge-oÅs and REO expense as a percent of average real estate securedreceivables(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ .70% .90% .71%
(1) Certain percentages may not recompute from the dollar Ñgures presented due to rounding.
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HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
ANALYSIS OF CREDIT LOSS RESERVES ACTIVITY Ó 2004
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Total Credit Loss Reserves at January 1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,793 $ 2,374 $ 6,167
Provision for Credit Losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,334 188 4,522
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4,408) (1,743) (6,151)Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (1) - (1)
Total receivables charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (4,409) (1,743) (6,152)
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 376 102 478Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - -
Total recoveries on receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 376 102 478Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (469) (31) (500)
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,612 890 4,502Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13 - 13
Total Credit Loss Reserves at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,625 $ 890 $ 4,515
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Reserves as a percentage of net charge-oÅs:Net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,033 89.9% $ 1,641 54.2% $ 5,674 79.6%Reserves as a percentage of receivables:Receivables:
Total consumerÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,875) (1,764) (5,639)Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3) - (3)
Total receivables charged oÅ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,878) (1,764) (5,642)
Total consumerÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 290 97 387Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 - 1
Total recoveries on receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 291 97 388Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80 7 87
Total consumerÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,762 2,374 6,136Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31 - 31
Total Credit Loss Reserves at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,793 $ 2,374 $ 6,167
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Reserves as a percentage of net charge-oÅs:
Net charge-oÅsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,587 105.7% $ 1,667 142.4% $ 5,254 117.4%Reserves as a percentage of receivables:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,391) (1,442) (4,833)Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2) - (2)
Total receivables charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3,393) (1,442) (4,835)
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 262 95 357Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 - 2
Total recoveries on receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 264 95 359Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 67 35 102
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,300 1,759 5,059Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 33 - 33
Total Credit Loss Reserves at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,333 $ 1,759 $ 5,092
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Reserves as a percentage of net charge-oÅs:
Net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,129 106.5% $ 1,347 130.6% $ 4,476 113.8%Reserves as a percentage of receivables:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,655) (1,101) (3,756)Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (12) - (12)
Total receivables charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,667) (1,101) (3,768)
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 257 68 325Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - -
Total recoveries on receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 257 68 325Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48 (6) 42
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,623 1,148 3,771Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 40 - 40
Total Credit Loss Reserves at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,663 $ 1,148 $ 3,811
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Reserves as a percentage of net charge-oÅs:
Net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,410 110.5% $ 1,033 111.2% $ 3,443 110.7%Reserves as a percentage of receivables:
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,110) (1,011) (3,121)Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (17) - (17)
Total receivables charged oÅÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,127) (1,011) (3,138)
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 205 59 264Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - -
Total recoveries on receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 205 59 264Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 160 (11) 149
Total consumer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,066 1,082 3,148Commercial and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 46 - 46
Total Credit Loss Reserves at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,112 $ 1,082 $ 3,194
Serviced withOwned Limited Recourse Managed
(dollars are in millions)
Reserves as a percentage of net charge-oÅs:
Net charge-oÅs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,921 109.9% $ 952 113.6% $ 2,873 111.1%Reserves as a percentage of receivables:
(1) Nonaccrual loans are included in average outstanding balances.(2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest
variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on therelative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of theindividual components
(3) Represents net interest income as a percent of average interest-earning assets(4) Represents the diÅerence between the yield earned on interest-earning assets and cost of the debt used to fund the assets.(5) Average rate does not recompute from dollar Ñgures presented due to rounding.
101
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
NET INTEREST MARGIN Ó 2003 COMPARED TO 2002
Finance and InterestIncome/Interest Increase/(Decrease) Due to:
(1) Nonaccrual loans are included in average outstanding balances.(2) Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total interest
variance. For total receivables, total interest-earning assets and total debt, the rate and volume variances are calculated based on therelative weighting of the individual components comprising these totals. These totals do not represent an arithmetic sum of theindividual components
(3) Represents net interest income as a percent of average interest-earning assets
(4) Represents the diÅerence between the yield earned on interest-earning assets and cost of the debt used to fund the assets.
(5) Average rate does not recompute from dollar Ñgures presented due to rounding.
102
HSBC FINANCE CORPORATION AND SUBSIDIARIES
RECONCILIATIONS TO GAAP FINANCIAL MEASURES
SELECTED FINANCIAL DATA AND STATISTICS
2004 2003 2002 2001 2000
(Restated)(dollars are in millions)
Return on Average Common Shareholder's(s') Equity:
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,940 $ 1,603 $ 1,558 $ 1,848 $ 1,631Dividends on preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (72) (76) (63) (16) (9)
Net income available to common shareholdersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,868 $ 1,527 $ 1,495 $ 1,832 $ 1,622Gain on bulk sale of private label receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (423) - - - -Adoption of FFIEC charge-oÅ policies for domestic private label and
MasterCard/Visa portfolios ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 121 - - - -HSBC acquisition related costs and other merger related items incurred
by HSBC Finance CorporationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - 167 - - -Settlement charge and related expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 333 - -Loss on the disposition of Thrift assets and deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 240 - -
Operating net income available to common shareholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,566 $ 1,694 $ 2,068 $ 1,832 $ 1,622
Average common shareholder's(s') equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 17,003 $ 14,209 $ 8,640 $ 7,589 $ 6,987
Return on average common shareholder's(s') equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11.0% 10.7% 17.3% 24.1% 23.2%Return on average common shareholder's(s') equity, operating basis ÏÏÏÏÏ 9.2 11.9 23.9 24.1 23.2
Return on Average Assets:
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,940 $ 1,603 $ 1,558 $ 1,848 $ 1,631Operating net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,638 1,770 2,131 1,848 1,631
Average assets:Owned basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $123,921 $110,097 $ 96,304 $ 81,782 $69,367Serviced with limited recourse ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 22,247 24,131 22,371 19,620 18,634
Return on average owned assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.57% 1.46% 1.62% 2.26% 2.35%Return on average owned assets, operating basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.32 1.61 2.21 2.26 2.35%Return on average managed assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.33 1.19 1.31 1.82 1.85Return on average managed assets, operating basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.12 1.32 1.80 1.82 1.85
EÇciency Ratio:
Total costs and expenses less policyholders' beneÑts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,189 $ 4,814 $ 4,447 $ 3,573 $ 3,027HSBC acquisition related costs and other merger related items incurred
by HSBC Finance CorporationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - (198) - - -Settlement charge and related expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (525) - -
Total costs and expenses less policyholders' beneÑts, excludingnonrecurring items ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,189 $ 4,616 $ 3,922 $ 3,573 $ 3,027
Net interest income and other revenues less policyholders' beneÑts:Owned basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 12,463 $ 11,256 $ 10,432 $ 9,304 $ 7,644Serviced with limited recourse ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 188 2,275 1,923 1,105 1,135
Nonrecurring items:Gain on bulk sale of private label receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 663 - - - -Adoption of FFIEC charge-oÅ policies for domestic private label and
MasterCard/Visa portfolios - ownedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 151 - - - -Adoption of FFIEC charge-oÅ policies for domestic private label and
MasterCard/Visa portfolios - managedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 107 - - - -Loss on the disposition of Thrift assets and deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - $ 378 - -
Net interest income and other revenues less policyholders' beneÑts,excluding nonrecurring items:Owned basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 11,951 $ 11,256 $ 10,810 $ 9,304 $ 7,644Serviced with limited recourse ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 144 2,275 1,923 1,105 1,135
Gain on bulk sale of private label receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 663 - - - -Loss on disposition of thrift assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 378 - -
Reserves as a percentage of net charge-oÅs, owned basis ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 89.9% 105.7% 106.5% 110.5% 109.9%Reserves as a percentage of net charge-oÅs, managed basis ÏÏÏÏÏÏÏÏÏÏÏÏÏ 79.6 117.4 113.8 110.7 111.1Reserves as a percentage of net charge-oÅs, owned operating basisÏÏÏÏÏÏÏ 109.2 105.7 106.5 110.5 109.9Reserves as a percentage of net charge-oÅs, managed operating basis ÏÏÏÏ 96.0 117.4 113.8 110.7 111.1
Common and preferred equity to owned assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13.01% 14.69% 10.64% 9.33% 10.26%Tangible common equity to tangible managed assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.67 5.04 6.83 6.24 6.25Tangible shareholder's(s') equity to tangible managed assetsÏÏÏÏÏÏÏÏÏÏÏÏ 6.68 7.03 9.08 7.57 7.13Tangible shareholder's(s') equity plus owned loss reserves to tangible
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this Item is included in sections of Item 7. Management's Discussion and Analysis ofFinancial Condition and Results of Operations on the following pages: ""Liquidity and Capital Resources'',pages 63-71, ""OÅ Balance Sheet Arrangements and Secured Financings'', pages 71-75, and ""Risk Manage-ment'', pages 75-79.
Item 8. Financial Statements and Supplementary Data.
Our 2004 Financial Statements meet the requirements of Regulation S-X. The 2004 Financial Statements andsupplementary Ñnancial information speciÑed by Item 302 of Regulation S-K are set forth below.
106
HSBC Finance Corporation
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and ShareholderHSBC Finance Corporation:
We have audited the accompanying consolidated balance sheets of HSBC Finance Corporation (a Delawarecorporation) (formerly Household International, Inc.), an indirect wholly-owned subsidiary of HSBCHoldings plc, and subsidiaries as of December 31, 2004 (successor basis) and December 31, 2003 (successorbasis) and the related consolidated statements of income, changes in shareholder's(s') equity, and cash Öowsfor the year ended December 31, 2004 (successor basis), for the periods January 1, 2003 through March 28,2003 (predecessor basis) and March 29, 2003 through December 31, 2003 (successor basis), and for the yearended December 31, 2002 (predecessor basis). These consolidated Ñnancial statements are the responsibilityof HSBC Finance Corporation's management. Our responsibility is to express an opinion on these consoli-dated Ñnancial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the Ñnancial statements are free of material misstatement. An audit includesconsideration of internal control over Ñnancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing an opinion on the eÅectiveness ofHSBC Finance Corporation's internal control over Ñnancial reporting. Accordingly, we express no suchopinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in theÑnancial statements. An audit also includes assessing the accounting principles used and signiÑcant estimatesmade by management, as well as evaluating the overall Ñnancial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.
In our opinion, the aforementioned consolidated Ñnancial statements present fairly, in all material respects, theÑnancial position of HSBC Finance Corporation and subsidiaries as of December 31, 2004 (successor basis)and December 31, 2003 (successor basis), and the results of their operations and their cash Öows for the yearended December 31, 2004 (successor basis) and March 29, 2003 through December 31, 2003 (successorbasis), in conformity with U.S. generally accepted accounting principles. Further, in our opinion, theaforementioned consolidated Ñnancial statements present fairly, in all material respects, the results ofoperations and cash Öows of HSBC Finance Corporation and subsidiaries for the period January 1, 2003through March 28, 2003 (predecessor basis) and for the year ended December 31, 2002 (predecessor basis),in conformity with U.S. generally accepted accounting principles.
As discussed in Note 4 to the consolidated Ñnancial statements, eÅective March 28, 2003, HSBC Holdings plcacquired all of the outstanding stock of Household International, Inc. (now HSBC Finance Corporation) in abusiness combination accounted for as a purchase. As a result of the acquisition, the consolidated Ñnancialinformation for the period after the acquisition is presented on a diÅerent cost basis than that for the periodsbefore the acquisition and, therefore, is not comparable.
As discussed in Note 3 to the consolidated Ñnancial statements, HSBC Finance Corporation has restated itsconsolidated Ñnancial statements as of December 31, 2003 (successor basis) and for the period March 29,2003 through December 31, 2003 (successor basis).
/s/ KPMG LLP
Chicago, IllinoisFebruary 28, 2005
107
HSBC Finance Corporation
CONSOLIDATED STATEMENT OF INCOME
March 29 January 1Year ended through through Year ended
December 31, December 31, March 28, December 31,2004 2003 2003 2002
Preferred stockBalance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,100 $ 1,100 $ 1,193 $ 456ReclassiÑcation of preferred stock issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 21 -Issuance of preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 737Redemption of preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (114) -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,100 $ 1,100 $ 1,100 $ 1,193
Common shareholder's(s') equityCommon stock
Balance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ - $ 552 $ 552EÅect of push-down accounting of HSBC's purchase price on net assets ÏÏÏÏÏÏ - - (552) -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ - $ - $ 552
Additional paid-in capitalBalance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,645 $ 14,661 $ 1,911 $ 2,030Return of capital to HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (31) (41) - -Employee beneÑt plans and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 13 25 10 50ReclassiÑcation of preferred stock issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (21) -Issuance of preferred stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - (11)Exercise of stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 5Common stock oÅering ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - (194)Issuance of adjustable conversion rate equity security unitsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 31EÅect of push-down accounting of HSBC's purchase price on net assets ÏÏÏÏÏÏ - - 12,761 -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,627 $ 14,645 $ 14,661 $ 1,911
Retained earningsBalance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,303 $ - $ 9,885 $ 8,838Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,940 1,357 246 1,558Dividends:
EÅect of push-down accounting of HSBC's purchase price on net assets ÏÏÏÏÏÏ - - (9,697) -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 571 $ 1,303 $ - $ 9,885
Accumulated other comprehensive incomeBalance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 443 $ - $ (695) $ (732)
Net change in unrealized gains (losses) on:Derivatives classiÑed as cash Öow hedges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 130 (11) 101 (37)Securities available for sale and interest-only strip receivables ÏÏÏÏÏÏÏÏÏÏÏ (114) 168 (25) 96
Other comprehensive income, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 200 443 52 37EÅect of push-down accounting of HSBC's purchase price on net assets ÏÏÏÏÏÏ - - 643 -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 643 $ 443 $ - $ (695)
Common stock in treasuryBalance at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - $ (2,431) $ (2,844)Exercise of stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 12 2Issuance of common stock for employee beneÑt plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 12 97Common stock oÅering ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 594Purchase of treasury stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (164) (280)EÅect of push-down accounting of HSBC's purchase price on net assets ÏÏÏÏÏÏ - - 2,571 -
Balance at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - (2,431)
Total common shareholder's(s') equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $15,841 $ 16,391 $ 14,661 $ 9,222
(in millions)Cash Öows from operating activitiesNet income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,940 $ 1,357 $ 246 $ 1,558Adjustments to reconcile net income to net cash provided by (used in)
operating activities:Provision for credit losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,334 2,991 976 3,732Gain on bulk sale of private label receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (663) - - -Insurance policy and claim reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (170) (196) 47 16Depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 483 344 53 233Deferred income tax provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 348 (83) 90 (120)Net change in interest-only strip receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 466 400 30 (199)Net change in other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (694) 899 (593) (136)Net change in other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 23 (735) 526 325Other, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 897 120 84 1,996
Net cash provided by (used in) operating activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,964 5,097 1,459 7,405
Net change in short-term securities available for sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 535 (2,684) (375) (1,254)Net change in securities purchased under agreements to resell ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,651 - - -Receivables:
Originations, net of collections ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (63,756) (41,644) (8,255) (47,363)Purchases and related premiumsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (608) (2,473) (129) (1,073)Initial and Ñll-up securitizations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 31,060 30,338 7,300 36,278Whole loan salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 6,287Sales to aÇliatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,279 2,844 - -
Net cash provided by (used in) investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (15,066) (14,367) (1,175) (9,749)
Cash Öows from Ñnancing activitiesDebt:
Net change in short-term debt and deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (180) 3,284 (514) (6,232)Net change in time certiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (161) (708) 150 (1,410)Disposition of Thrift deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - (4,259)Net change in due to aÇliates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,716 7,023 - -Long term debt issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 19,916 15,559 4,361 30,620Long term debt retiredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (14,628) (15,789) (4,030) (16,276)Issuance of company obligated mandatorily redeemable preferred securities
of subsidiary trusts to HSBC ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - 275 - -Redemption of company obligated mandatorily redeemable preferred
securities of subsidiary trustsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - (275) - -Insurance:
Policyholders' beneÑts paid ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (194) (121) (36) (286)Cash received from policyholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 265 127 33 92
Shareholder's(s') dividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,708) (293) (141) (510)Issuance of preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 726Redemption of preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (114) -Common stock oÅering ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - - 400Purchase of treasury stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (164) (280)Issuance of common stock for employee beneÑt plansÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 62 136
Net cash provided by (used in) Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,026 9,082 (393) 2,721
EÅect of exchange rate changes on cash ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5 (23) (15) (123)
Net change in cashÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (71) (211) (124) 254Cash at beginning of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 463 674 798 544
Cash at end of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 392 $ 463 $ 674 $ 798
Supplemental Noncash Financing and Capital Activities:Push-down of purchase price by HSBCÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ - $14,661 $ -Exchange of preferred stock for preferred stock issued to HSBCÏÏÏÏÏÏÏÏÏÏÏÏÏ - - 1,100 -
The accompanying notes are an integral part of the consolidated Ñnancial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
HSBC Finance Corporation (formerly Household International, Inc.) and its subsidiaries were acquired by awholly owned subsidiary of HSBC Holdings plc (""HSBC'') on March 28, 2003 in a purchase businesscombination recorded under the ""push-down'' method of accounting, which resulted in a new basis ofaccounting for the ""successor'' period beginning March 29, 2003. Information relating to all ""predecessor''periods prior to the acquisition is presented using the historical basis of accounting.
On September 30, 2004, Household International, Inc. (""Household'') commenced the rebranding of themajority of its U.S. and Canadian businesses to the HSBC brand. Businesses previously operating under theHousehold name are now called HSBC. Our consumer lending business has retained the HFC and BeneÑcialbrands, accompanied by the HSBC Group's endorsement signature, ""Member HSBC Group.'' The singlebrand allows HSBC in North America to better align its businesses, providing a stronger platform to servicecustomers and advance growth. The HSBC brand also positions us to expand the products and services oÅeredto our customers. As part of this initiative, Household changed its name to HSBC Finance Corporation inDecember 2004.
HSBC Finance Corporation and subsidiaries, is an indirect wholly owned subsidiary of HSBC North AmericaHoldings Inc. (""HNAH''), which is a wholly-owned subsidiary of HSBC. HSBC Finance Corporationprovides middle-market consumers with several types of loan products in the United States, the UnitedKingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. HSBC Finance Corporationmay also be referred to in these notes to the consolidated Ñnancial statements as ""we,'' ""us'' or ""our.'' Ourlending products include real estate secured loans, auto Ñnance loans, MasterCard* and Visa* credit cardloans, private label credit card loans and personal non-credit card loans. We also initiate tax refundanticipation loans in the United States and oÅer credit and specialty insurance in the United States, theUnited Kingdom and Canada. We have three reportable segments: Consumer, Credit Card Services, andInternational. Our Consumer segment consists of our branch-based consumer lending, mortgage services,retail services, and auto Ñnance businesses. Our Credit Card Services segment consists of our domesticMasterCard and Visa credit card business. Our International segment consists of our foreign operations in theUnited Kingdom (""U.K.''), the Republic of Ireland, the Czech Republic, Hungary and Canada.
2. Summary of SigniÑcant Accounting Policies
Basis of Presentation The consolidated Ñnancial statements include the accounts of HSBC FinanceCorporation and all subsidiaries including all variable interest entities in which we are the primary beneÑciaryas deÑned by Financial Accounting Standards Board Interpretation (""FASB'') No. 46 (Revised). UnaÇli-ated trusts to which we have transferred securitized receivables which are qualifying special purpose entities(""QSPE'') as deÑned by Statement of Financial Accounting Standards (""SFAS'') No. 140, ""Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities, a Replacement of FASBStatement No. 125,'' are not consolidated. All signiÑcant intercompany accounts and transactions have beeneliminated.
The preparation of Ñnancial statements in conformity with accounting principles generally accepted in theUnited States (""U.S. GAAP'') requires management to make estimates and assumptions that aÅect theamounts reported in the Ñnancial statements and accompanying notes. Actual results could diÅer from thoseestimates.
Certain reclassiÑcations have been made to prior period amounts to conform to the current periodpresentation. Immaterial adjustments have been made to decrease Ñnance income and increase securitizationrevenue as reported in prior periods. These adjustments reÖect corrections after discovery of a systemprogramming error in the posting of Ñnance income between owned receivables and receivables serviced withlimited recourse. Reported net income for all prior periods was not aÅected by these adjustments.
* MasterCard is a registered trademark of MasterCard International, Incorporated and VISA is a registered trademark of VISA USA,
Inc.
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Securities purchased under agreements to resell Securities purchased under agreements to resell are treated ascollateralized Ñnancing transactions and are carried at the amounts at which the securities were acquired plusaccrued interest. Interest income earned on these securities is included in net interest income.
Investment Securities We maintain investment portfolios (comprised primarily of debt securities and moneymarket funds) in both our noninsurance and insurance operations. Our entire investment securities portfoliowas classiÑed as available-for-sale at December 31, 2004 and 2003. Available-for-sale investments areintended to be invested for an indeÑnite period but may be sold in response to events we expect to occur in theforeseeable future. These investments are carried at fair value. Unrealized holding gains and losses onavailable-for-sale investments are recorded as adjustments to common shareholder's(s') equity in accumu-lated other comprehensive income, net of income taxes. Any decline in the fair value of investments which isdeemed to be other than temporary is charged against current earnings.
Cost of investment securities sold is determined using the speciÑc identiÑcation method. Interest incomeearned on the noninsurance investment portfolio is classiÑed in the statements of income in net interestincome. Realized gains and losses from the investment portfolio and investment income from the insuranceportfolio are recorded in investment income. Accrued investment income is classiÑed with investmentsecurities.
Receivables Receivables are carried at amortized cost. As a result of the merger with HSBC, the amortizedcost of our receivables was adjusted to fair market value at the time of the merger. Finance income isrecognized using the eÅective yield method. Premiums and discounts, including purchase accounting fairvalue adjustments on receivables, are recognized as adjustments to the yield of the related receivables.Origination fees, which include points on real estate secured loans, are deferred and amortized to Ñnanceincome over the estimated life of the related receivables, except to the extent they oÅset directly relatedlending costs. Net deferred origination fees, excluding MasterCard and Visa, totaled $43 million atDecember 31, 2004 and $172 million at December 31, 2003. MasterCard and Visa annual fees are netted withdirect lending costs, deferred, and amortized on a straight-line basis over one year. Deferred MasterCard andVisa annual fees, net of direct lending costs related to these receivables, totaled $107 million at December 31,2004 and $57 million at December 31, 2003.
Insurance reserves and unearned premiums applicable to credit risks on consumer receivables are treated as areduction of receivables in the balance sheet, since payments on such policies generally are used to reduceoutstanding receivables.
Provision and Credit Loss Reserves Provision for credit losses on owned receivables is made in an amountsuÇcient to maintain credit loss reserves at a level considered adequate, but not excessive, to cover probablelosses of principal, interest and fees, including late, overlimit and annual fees, in the existing owned portfolio.We estimate probable losses for owned consumer receivables using a roll rate migration analysis that estimatesthe likelihood that a loan will progress through the various stages of delinquency, or buckets, and ultimatelycharge oÅ. This analysis considers delinquency status, loss experience and severity and takes into accountwhether loans are in bankruptcy, have been restructured, rewritten or are subject to forbearance, an externaldebt management plan, hardship, modiÑcation, extension or deferment. Our credit loss reserves also take intoconsideration the loss severity expected based on the underlying collateral, if any, for the loan in the event ofdefault. Delinquency status may be aÅected by customer account management policies and practices, such asthe restructure of accounts, forbearance agreements, extended payment plans, modiÑcation arrangements,external debt management programs, loan rewrites and deferments. When customer account managementpolicies, or changes thereto, shift loans from a ""higher'' delinquency bucket to a ""lower'' delinquency bucket,this will be reÖected in our roll rate statistics. To the extent that restructured accounts have a greaterpropensity to roll to higher delinquency buckets, this will be captured in the roll rates. Since the loss reserve iscomputed based on the composite of all of these calculations, this increase in roll rate will be applied toreceivables in all respective delinquency buckets, which will increase the overall reserve level. In addition, lossreserves on consumer receivables are maintained to reÖect our judgment of portfolio risk factors which maynot be fully reÖected in the statistical roll rate calculation. Risk factors considered in establishing loss reserveson consumer receivables include recent growth, product mix, bankruptcy trends, geographic concentrations,
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economic conditions, portfolio seasoning, account management policies and practices and current levels ofcharge-oÅs and delinquencies. For commercial loans, probable losses are calculated using estimates ofamounts and timing of future cash Öows expected to be received on loans.
While our credit loss reserves are available to absorb losses in the entire portfolio, we speciÑcally consider thecredit quality and other risk factors for each of our products. We recognize the diÅerent inherent losscharacteristics in each of our products as well as customer account management policies and practices and riskmanagement/collection practices. Charge-oÅ policies are also considered when establishing loss reserverequirements to ensure appropriate allowances exist for products with longer charge-oÅ periods. We alsoconsider key ratios such as reserves to nonperforming loans and reserves as a percentage of net charge-oÅs indeveloping our loss reserve estimate. Loss reserve estimates are reviewed periodically and adjustments arereported in earnings when they become known. As these estimates are inÖuenced by factors outside ourcontrol, such as consumer payment patterns and economic conditions, there is uncertainty inherent in theseestimates, making it reasonably possible that they could change.
Charge-OÅ and Nonaccrual Policies and Practices In December 2004, upon receipt of regulatory approval forthe sale of our domestic private label portfolio to HSBC Bank USA, National Association (""HSBC BankUSA''), we adopted charge-oÅ and account management policies in accordance with the Uniform RetailCredit ClassiÑcation and Account Management Policy issued by the Federal Financial Institutions Examina-tion Council (""FFIEC'') for our domestic private label and MasterCard/Visa portfolios. See Note 5, ""Sale ofDomestic Private Label Receivable Portfolio and Adoption of FFIEC Policies.''
Our consumer charge-oÅ and nonaccrual policies vary by product and are summarized below:
Product Charge-oÅ Policies and Practices Nonaccrual Policies and Practices(1)
Real estate Secured(2,4) Carrying values in excess of net Interest income accruals arerealizable value are charged-oÅ suspended when principal orat or before the time foreclosure interest payments are more thanis completed or when settlement three months contractually pastis reached with the borrower. If due and resumed when theforeclosure is not pursued, and receivable becomes less thanthere is no reasonable expectation three months contractually pastfor recovery(insurance claim, title due.claim, pre-discharge bankruptaccount), generally the accountwill be charged-oÅ by the end ofthe month in which the accountbecomes nine monthscontractually delinquent.
Auto Ñnance(4) Carrying values in excess of net Interest income accruals arerealizable value are charged oÅ suspended and the portion ofat the earlier of the following: previously accrued interest
‚ the collateral has been expected to be uncollectible isrepossessed and sold, written oÅ when principal
‚ the collateral has been in our payments are more than twopossession for more than months contractually past due90 days, or and resumed when the receivable
‚ the loan becomes 150 days becomes less than two monthscontractually delinquent. contractually past due.
MasterCard and Visa(5) Generally charged-oÅ by the end Interest generally accrues untilof the month in which the charge-oÅ.account becomes six monthscontractually delinquent.
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Product Charge-oÅ Policies and Practices Nonaccrual Policies and Practices(1)
Private label(3, 5) Prior to December 2004, Interest generally accrues untilreceivables were generally charged- charge-oÅ.off the month following the monthin which the account became ninemonths contractually delinquent.Beginning in the fourth quarter of2002, receivables originatedthrough new domestic merchantrelationships were charged-off bythe end of the month in which theaccount became six monthscontractually delinquent.Subsequent to the adoption ofFFIEC policies in December 2004,domestic receivables are charged-off by the end of the month inwhich the account becomes sixmonths contractually delinquent.
Personal non-credit card(3) Generally charged-oÅ the month Interest income accruals arefollowing the month in which the suspended when principal oraccount becomes nine months interest payments are more thancontractually delinquent and no three months contractuallypayment received in six months, delinquent. For PHLs, interestbut in no event to exceed income accruals resume if the12 months contractually receivable becomes less thandelinquent (except in our United three months contractually pastKingdom business which may be due. For all other personal non-longer). credit card receivables for which
income accruals are suspended,interest income is generallyrecorded as collected.
(1) For our United Kingdom business, interest income accruals are suspended when principal or interest payments are more than threemonths contractually delinquent.
(2) For our United Kingdom business, real estate secured carrying values in excess of net realizable value are charged-oÅ at time of sale.(3) For our Canada business, the private label and personal non-credit card charge-oÅ policy prior to December 2004 required a charge-
oÅ of an account where no payment was received in six months, but in no event was an account to exceed 18 months contractuallydelinquent. In December 2004, the policy was revised to charge-oÅ accounts when no payment is received in six months but in noevent is an account to exceed 12 months contractually delinquent. This policy change was not part of the adoption of FFIEC policiesdiscussed in Note 5 and its impact was not material to our net income.
(4) In November 2003, the FASB issued FASB StaÅ Position Number 144-1, ""Determination of Cost Basis for Foreclosed Assets underFASB Statement No. 15, and the Measurement of Cumulative Losses Previously Recognized Under Paragraph 37 of FASBStatement No. 144'' (""FSP 144-1''). Under FSP 144-1, sales commissions related to the sale of foreclosed assets are recognized as acharge-oÅ through the provision for credit losses. Previously, we had recognized sales commission expense as a component of otherservicing and administrative expenses in our statements of income. We adopted FSP 144-1 in November 2003. The adoption had nosigniÑcant impact on our net income.
(5) For our United Kingdom business, delinquent MasterCard/Visa accounts are charged-oÅ the month following the month in which theaccount becomes six months contractually delinquent and delinquent private label receivables are charged-oÅ the month following themonth in which the account becomes nine months contractually delinquent.
Charge-oÅ involving a bankruptcy for our domestic private label and MasterCard and Visa receivables occursby the end of the month 60 days after notiÑcation or 180 days delinquent, whichever is sooner. For autoÑnance receivables, bankrupt accounts are charged oÅ no later than the end of the month in which the loanbecomes 210 days contractually delinquent. Prior to December 2004, charge-oÅs involving a bankruptcy forour domestic private label receivables occurred by the end of the month 90 days after notiÑcation.
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Receivables Sold and Serviced with Limited Recourse and Securitization Revenue Certain real estate secured,auto Ñnance, MasterCard and Visa, private label and personal non-credit card receivables have beensecuritized and sold to investors with limited recourse. We have retained the servicing rights to thesereceivables. Recourse is limited to our rights to future cash Öow and any subordinated interest that we mayretain. Upon sale, the receivables are removed from the balance sheet and a gain on sale is recognized for thediÅerence between the carrying value of the receivables and the adjusted sales proceeds. The adjusted salesproceeds include cash received and the present value estimate of future cash Öows to be received over the livesof the sold receivables. Future cash Öows are based on estimates of prepayments, the impact of interest ratemovements on yields of receivables and securities issued, delinquency of receivables sold, servicing fees andother factors. The resulting gain is also adjusted by a provision for estimated probable losses under therecourse provision. This provision and the related reserve for receivables serviced with limited recourse areestablished at the time of sale to cover all probable credit losses over-the-life of the receivables sold based onhistorical experience and estimates of expected future performance. The methodologies vary depending uponthe type of receivable sold, using either historical monthly net charge-oÅ rates applied to the expectedbalances to be received over the remaining life of the receivable or a historical static pool analysis. Thereserves are reviewed periodically by evaluating the estimated future cash Öows of each securitized pool toensure that there is suÇcient remaining cash Öow to cover estimated future credit losses. Any changes to theestimates for the reserve for receivables serviced with limited recourse are made in the period they becomeknown. Gains on sale net of recourse provisions, servicing income and excess spread relating to securitizedreceivables are reported in the accompanying consolidated statements of income as securitization revenue.
In connection with these transactions, we record an interest-only strip receivable, representing our contractualright to receive interest and other cash Öows from our securitization trusts. Our interest-only strip receivablesare reported at fair value using discounted cash Öow estimates as a separate component of receivables net ofour estimate of probable losses under the recourse provisions. Cash Öow estimates include estimates ofprepayments, the impact of interest rate movements on yields of receivables and securities issued, delinquencyof receivables sold, servicing fees and estimated probable losses under the recourse provisions. Unrealizedgains and losses are recorded as adjustments to common shareholder's(s') equity in accumulated othercomprehensive income, net of income taxes. Our interest-only strip receivables are reviewed for impairmentquarterly or earlier if events indicate that the carrying value may not be recovered. Any decline in the fairvalue of the interest-only strip receivable which is deemed to be other than temporary is charged againstcurrent earnings.
We have also, in certain cases, retained other subordinated interests in these securitizations. Neither theinterest-only strip receivables nor the other subordinated interests are in the form of securities.
In order to align our accounting treatment with that of HSBC under U.K. GAAP (and beginning in 2005International Financial Reporting Standards), we began to structure all new funding utilizing securitization assecured Ñnancings beginning in the third quarter of 2004. However, because existing public MasterCard andVisa credit card transactions were structured as sales to revolving trusts that require replenishments to supportpreviously issued securities, receivables will continue to be sold to these trusts until the revolving periods end.We have continued to replenish, at reduced levels, certain non-public personal non-credit card andMasterCard and Visa securities issued to conduits and recorded the resulting replenishment gains in order tomanage liquidity.
Properties and Equipment, Net Properties and equipment are recorded at cost, net of accumulated deprecia-tion and amortization. As a result of our acquisition by HSBC, the amortized cost of our properties andequipment was adjusted to fair market value and accumulated depreciation and amortization on a ""predeces-sor'' basis was eliminated at the time of the merger. For Ñnancial reporting purposes, depreciation is providedon a straight-line basis over the estimated useful lives of the assets which generally range from 3 to 40 years.Leasehold improvements are amortized over the lesser of the economic useful life of the improvement or theterm of the lease. Maintenance and repairs are expensed as incurred.
Repossessed Collateral Real estate owned is valued at the lower of cost or fair value less estimated costs tosell. These values are periodically reviewed and reduced, if necessary. Costs of holding real estate and related
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gains and losses on disposition are credited or charged to operations as incurred as a component of operatingexpense. Repossessed vehicles, net of loss reserves when applicable, are recorded at the lower of the estimatedfair market value or the outstanding receivable balance.
Insurance Insurance revenues on monthly premium insurance policies are recognized when billed. Insurancerevenues on the remaining insurance contracts are recorded as unearned premiums and recognized intoincome based on the nature and terms of the underlying contracts. Liabilities for credit insurance policies arebased upon estimated settlement amounts for both reported and incurred but not yet reported losses.Liabilities for future beneÑts on annuity contracts and specialty and corporate owned life insurance productsare based on actuarial assumptions as to investment yields, mortality and withdrawals.
Intangible Assets Intangible assets consist of purchased credit card relationships and related programs, retailservices merchant relationships, other loan related relationships, trade names, technology, customer lists andother contracts. The trade names are not subject to amortization as we believe they have inÑnite lives. Theremaining intangible assets are being amortized over their estimated useful lives either on a straight-line basisor in proportion to the underlying revenues generated. These useful lives range from 5 years for retail servicesmerchant relationships to approximately 10 years for certain loan related relationships. Intangible assets arereviewed for impairment using discounted cash Öows annually or earlier if events indicate that the carryingamounts may not be recoverable. We consider signiÑcant and long-term changes in industry and economicconditions to be our primary indicator of potential impairment. Impairment charges, when required, arecalculated using discounted cash Öows.
Goodwill Goodwill represents the purchase price over the fair value of identiÑable assets acquired lessliabilities assumed from business combinations. Goodwill is not amortized, but is reviewed for impairmentannually using discounted cash Öows but impairment may be reviewed earlier if circumstances indicate thatthe carrying amount may not be recoverable. We consider signiÑcant and long-term changes in industry andeconomic conditions to be our primary indicator of potential impairment.
Treasury Stock Prior to the merger with HSBC, repurchases of treasury stock were accounted for using thecost method with common stock in treasury classiÑed in the balance sheets as a reduction of commonshareholders' equity. Treasury stock was reissued at average cost.
Derivative Financial Instruments All derivatives are recognized on the balance sheet at their fair value. Onthe date the derivative contract is entered into, we designate the derivative as a fair value hedge, a cash Öowhedge, a hedge of a net investment in a foreign operation, or a non-hedging derivative. Fair value hedgesinclude hedges of the fair value of a recognized asset or liability and certain foreign currency hedges. CashÖow hedges include hedges of the variability of cash Öows to be received or paid related to a recognized assetor liability and certain foreign currency hedges. Changes in the fair value of derivatives designated as fair valuehedges, along with the change in fair value on the hedged asset or liability that is attributable to the hedgedrisk, are recorded in current period earnings.
Changes in the fair value of derivatives designated as cash Öow hedges, to the extent eÅective as a hedge, arerecorded in accumulated other comprehensive income and reclassiÑed into earnings in the period during whichthe hedged item aÅects earnings. Changes in the fair value of derivatives used to hedge our net investment inforeign subsidiaries, to the extent eÅective as a hedge, are recorded in common shareholder's(s') equity as acomponent of the cumulative translation adjustment account within accumulated other comprehensiveincome. Changes in the fair value of derivative instruments not designated as hedging instruments andineÅective portions of changes in the fair value of hedging instruments are recognized in other revenue asderivative income in the current period.
For derivative instruments designated as hedges, we formally document all relationships between hedginginstruments and hedged items. This documentation includes our risk management objective and strategy forundertaking various hedge transactions, as well as how hedge eÅectiveness and ineÅectiveness will bemeasured. This process includes linking derivatives to speciÑc assets and liabilities on the balance sheet. Wealso formally assess, both at the hedge's inception and on an ongoing basis, whether the derivatives that areused in hedging transactions are highly eÅective in oÅsetting changes in fair values or cash Öows of hedged
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items. This assessment is conducted using statistical regression analysis or using a matching of critical terms.For interest rate swaps which meet the shortcut method criteria under Statement of Financial AccountingStandards No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' (""SFAS 133''), noassessment is required. When it is determined that a derivative is not highly eÅective as a hedge or that it hasceased to be a highly eÅective hedge, we discontinue hedge accounting prospectively.
When hedge accounting is discontinued because it is determined that the derivative no longer qualiÑes as aneÅective hedge, the derivative will continue to be carried on the balance sheet at its fair value, with changes inits fair value recognized in current period earnings. For fair value hedges, the formerly hedged asset or liabilitywill no longer be adjusted for changes in fair value and any previously recorded adjustments to the carryingvalue of the hedged asset or liability will be amortized in the same manner that the hedged item aÅectsincome. For cash Öow hedges, amounts previously recorded in accumulated other comprehensive income willbe reclassiÑed into income as earnings are impacted by the variability in the cash Öows of the hedged item.
If the hedging instrument is terminated early, the derivative is removed from the balance sheet. Accountingfor the adjustments to the hedged asset or liability or adjustments to accumulated other comprehensiveincome are the same as described above when a derivative no longer qualiÑes as an eÅective hedge.
If the hedged asset or liability is sold or extinguished, the derivative will continue to be carried on the balancesheet at its fair value, with changes in its fair value recognized in current period earnings. The hedged item,including previously recorded mark-to-market adjustments, is derecognized immediately as a component ofthe gain or loss upon disposition.
Foreign Currency Translation We have foreign subsidiaries located in the United Kingdom and Canada. Thefunctional currency for each foreign subsidiary is its local currency. Assets and liabilities of these subsidiariesare translated at the rate of exchange in eÅect on the balance sheet date. Translation adjustments resultingfrom this process are accumulated in common shareholder's(s') equity as a component of accumulated othercomprehensive income. Income and expenses are translated at the average rate of exchange prevailing duringthe year.
Prior to our merger with HSBC, we periodically entered into forward exchange contracts and foreign currencyoptions to hedge our investment in foreign subsidiaries. After-tax gains and losses on contracts to hedgeforeign currency Öuctuations are accumulated in common shareholder's(s') equity as a component ofaccumulated other comprehensive income. EÅects of foreign currency translation in the statements of cashÖows are oÅset against the cumulative foreign currency adjustment, except for the impact on cash. Foreigncurrency transaction gains and losses are included in income as they occur.
Stock-Based Compensation In 2002, we adopted the fair value method of accounting for our stock option andemployee stock purchase plans. We elected to recognize stock compensation cost prospectively for all newawards granted under those plans beginning January 1, 2002 as provided under SFAS No. 148, ""Accountingfor Stock-Based Compensation Ó Transition and Disclosure (an amendment of FASB Statement No. 123'')(""SFAS No. 148''). The fair value of these awards granted beginning in 2002 is recognized as expense overthe vesting period, generally either three or four years. As option expense is recognized over the vesting periodof the awards, compensation expense included in the determination of net income for 2003 and 2002 does notreÖect the expense which would have been recognized if the fair value method had been applied to all awardssince the original eÅective date of FASB Statement No. 123. Because options granted prior to November 2002vested upon completion of the merger with HSBC on March 28, 2003, all of our stock options are nowaccounted for using the fair value method. In 2004, we began to consider forfeitures for all stock awardsgranted subsequent to March 28, 2003 as part of our estimate of compensation expense rather than adjustcompensation expense as forfeitures occur. The cumulative impact of the change was not material.
Compensation expense relating to restricted stock rights (""RSRs'') is based upon the market value of theRSRs on the date of grant and is charged to earnings over the vesting period of the RSRs, generally three orÑve years.
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The following table illustrates the eÅect on net income if the fair value method had been applied to alloutstanding and unvested awards in the periods prior to the merger.
January 1through Year ended
March 28, December 31,2003 2002
(Predecessor) (Predecessor)(in millions)
Net income, as reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $246 $1,558
Add stock-based employee compensation expense included in reported netincome, net of tax:
Stock option and employee stock purchase plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7 3
Restricted stock rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11 36
Deduct stock-based employee compensation expense determined under thefair value method, net of tax:
Stock option and employee stock purchase plans ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (53) (31)
Restricted stock rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (45) (36)
Pro forma net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $166 $1,530
Income Taxes HSBC Finance Corporation is included in HNAH's consolidated federal income tax return andin various state income tax returns. In addition, HSBC Finance Corporation Ñles some unconsolidated statetax returns. Deferred tax assets and liabilities are determined based on diÅerences between Ñnancial reportingand tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are in eÅect.Investment tax credits generated by leveraged leases are accounted for using the deferral method. Changes inestimates of the basis in our assets and liabilities or other estimates recorded at the date of our merger withHSBC are adjusted against goodwill.
Transactions with Related Parties In the normal course of business, we enter into transactions with HSBCand its subsidiaries. These transactions include funding arrangements, purchases and sales of receivables,servicing arrangements, information technology services, item processing and statement processing services,banking and other miscellaneous services.
New Accounting Pronouncements In December 2003, the American Institute of CertiÑed Public Accountants(""AICPA'') released Statement of Position 03-3, ""Accounting for Certain Loans or Debt Securities Acquiredin a Transfer'' (""SOP 03-3''). SOP 03-3 addresses accounting for diÅerences between contractual cash Öowsand cash Öows expected to be collected from an investor's initial investment in loans or debt securitiesacquired in a transfer if those diÅerences are attributable to credit quality. SOP 03-3 is eÅective for loansacquired in Ñscal years beginning after December 15, 2004. Adoption is not expected to have a materialimpact on our Ñnancial position or results of operations.
In January 2004, the FASB issued FASB StaÅ Position 106-1, ""Accounting and Disclosure RequirementsRelated to the Medicare Prescription Drug, Improvement and Modernization Act of 2003'' (FSP 106-1).FSP 106-1 was issued in response to a new Medicare bill that provides prescription drug coverage toMedicare-eligible retirees and was signed into law in December 2003. FSP 106-1 allowed plan sponsors theoption of accounting for the eÅects of this new law in Ñnancial statements that cover the date of enactment ormaking a one-time election to defer the accounting for the eÅects of the new law. We elected to defer theaccounting for the eÅects of the new law. In May 2004, FASB issued FASB StaÅ Position FAS 106-2,""Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement andModernization Act of 2003'' (""FSP 106-2'') which superceded FSP 106-1. FSP 106-2 provided two methodsof transition Ó retroactive application or prospective application from the date of adoption. If the eÅects of thenew law are deemed not to be a ""signiÑcant event,'' the eÅect can be incorporated into the next measurementdate following the eÅective date. Based on information currently available, we do not consider the eÅects ofthe new law to be a ""signiÑcant event'' and therefore we have accounted for the eÅects of the new law in themeasurement of pension liability at December 31, 2004.
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In March 2004, the FASB reached a consensus on EITF 03-1, ""The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments'' (""EITF 03-1''). EITF 03-1 provides guidance fordetermining when an investment is impaired and whether the impairment is other than temporary. EITF 03-1also incorporates into its consensus the required disclosures about unrealized losses on investments announcedby the EITF in late 2003 and adds new disclosure requirements relating to cost-method investments. The newdisclosure requirements are eÅective for annual reporting periods ending after June 15, 2004 and the newimpairment accounting guidance was to become eÅective for reporting periods beginning after June 15, 2004.In September 2004, the FASB delayed the eÅective date of EITF 03-1 for measurement and recognition ofimpairment losses until implementation guidance is issued. In December 2004, the FASB decided toreconsider in its entirety all guidance on disclosing, measuring and recognizing other-than-temporaryimpairments of debt and equity securities and requires companies to continue to comply with existingaccounting literature. Until the new guidance is Ñnalized, the impact on our Ñnancial position and results ofoperations can not be determined.
In December 2004, the FASB issued FASB Statement No. 123(Revised), ""Share-Based Payment,''(""SFAS No. 123R''). SFAS No. 123R requires public entities to measure the cost of stock-basedcompensation based on the grant date fair value of the award, and is eÅective for interim periods beginningafter June 15, 2005. Because we currently apply the fair value method of accounting for all equity basedawards, the adoption of SFAS 123R will not have a signiÑcant eÅect on the results of our operations or othercash Öows.
3. Restatement
HSBC Finance Corporation has restated its consolidated Ñnancial statements for the previously reportedperiod March 29, 2003 through December 31, 2003. This Form 10-K and the exhibits included herewithinclude all adjustments relating to the restatement for this prior period.
During the fourth quarter of 2004, as part of our preparation for the implementation of International FinancialReporting Standards (""IFRS'') by HSBC from January 1, 2005, we undertook a review of our hedgingactivities to conÑrm conformity with the accounting requirements of IFRS, which diÅer in several respectsfrom the hedge accounting requirements under U.S. GAAP as set out in SFAS 133. As a result of this review,management determined that there were some deÑciencies in the documentation required to support hedgeaccounting under U.S. GAAP. These documentation deÑciencies arose following our acquisition by HSBC.As a consequence of the acquisition, pre-existing hedging relationships, including hedging relationships thathad previously qualiÑed under the ""shortcut'' method of accounting pursuant to SFAS 133, were required tobe reestablished. At that time there was some debate in the accounting profession regarding the detailedtechnical requirements resulting from a business combination. We consulted with our independent accountants,KPMG LLP, in reaching a determination of what was required in order to comply with SFAS 133. Followingthis, we took the actions we believed were necessary to maintain hedge accounting for all of our historicalhedging relationships in our consolidated financial statements for the period ended December 31, 2003 and thoseconsolidated financial statements received an unqualified audit opinion.
Management, having determined during the fourth quarter of 2004 that there were certain documentationdeÑciencies, engaged independent expert consultants to advise on the continuing eÅectiveness of the identiÑedhedging relationships. As a result of this assessment, we concluded that a substantial number of our hedgesmet the correlation eÅectiveness requirements of SFAS 133 throughout the period following our acquisition byHSBC. However, we also determined in conjunction with KPMG LLP that, although a substantial number ofthe impacted hedges satisÑed the correlation eÅectiveness requirement of SFAS 133, there were technicaldeÑciencies in the documentation that could not be corrected retroactively or disregarded notwithstanding theproven eÅectiveness of the hedging relationships in place and, consequently, that the requirements ofSFAS 133 were not met and that hedge accounting was not appropriate during the period these documenta-tion deÑciencies existed. We have therefore determined that we should restate all the reported periods sinceour acquisition by HSBC to eliminate hedge accounting on all hedging relationships outstanding at March 29,2003 and certain fair value swaps entered into after that date. This was accomplished primarily by reclassifying
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the mark to market of the changes in fair market value of the aÅected derivative Ñnancial instrumentspreviously classiÑed in either debt or other comprehensive income into current period earnings.
The period to period changes in the fair value of these derivative Ñnancial instruments have been recognized aseither an increase or decrease in our current period earnings through derivative income. As part of therestatement process, we have reclassiÑed all previous hedging results reÖected in interest expense associatedwith the aÅected derivative Ñnancial instruments to derivative income.
The restatement eÅect on our pre-tax income and net income for the period March 29, 2003 throughDecember 31, 2003 is summarized below:
Restatements to Reported Income
% ChangePre-Tax Tax EÅect After-Tax to Reported
(dollars in millions)
March 29, 2003 through December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(97) $ 35 $(62) (4.4)%
A detailed summary of the impact of the restatement on our consolidated statement of income and on ourconsolidated balance sheet for the period March 29, 2003 through December 31, 2003 is as follows:
March 29, 2003through
December 31, 2003
AsPreviously AsReported Restated
(in millions)
Consolidated Statement of Income:
Net interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,048* $ 5,742
Other revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,897* 3,107
Income before income tax expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,144 2,047
Income tax expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 725 690
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1,419 $ 1,357
Derivative related liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 600 597
Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,228 3,131
Common shareholder's equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16,561 16,391
* Certain reclassiÑcations have been made to prior period amounts to conform to the current year presentation.
The resulting accounting does not reÖect the economic reality of our hedging activity and has no impact on thetiming or amount of operating cash Öows or cash Öows under any debt or derivative contract. It does not aÅectour ability to make required payments on our outstanding debt obligations. Furthermore, our economic riskmanagement strategies have not required amendment.
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4. Acquisitions and Divestitures
Acquisition by HSBC Holdings plc On March 28, 2003, we were acquired by HSBC by way of merger in apurchase business combination. HSBC believes that the acquisition oÅers signiÑcant opportunities to extendour business model into countries and territories currently served by HSBC and broadens the product rangeavailable to the enlarged customer base. Under the terms of the acquisition agreement, each share of ourapproximately 476 million outstanding common shares at the time of acquisition was converted into the rightto receive, at the holder's election, either 2.675 ordinary shares of HSBC, of nominal value $0.50 each(""HSBC Ordinary Shares''), or 0.535 American depositary shares, each representing an interest in Ñve HSBCOrdinary Shares. Additionally, each of our depositary shares representing, respectively, one-fortieth of a shareof 81/4% cumulative preferred stock, Series 1992-A, one-fortieth of a share of 7.50% cumulative preferredstock, Series 2001-A, one-fortieth of a share of 7.60% cumulative preferred stock, Series 2002-A and one-fortieth of a share of 75/8% cumulative preferred stock, Series 2002-B, was converted into the right to receive$25 in cash per depositary share, plus accrued and unpaid dividends up to but not including the eÅective dateof the acquisition which was an aggregate amount of approximately $1.1 billion. In consideration of HSBCtransferring suÇcient funds to make the payments described above with respect to our depositary shares, weissued the Series A Cumulative Preferred Stock (""Series A preferred stock'') in the amount of $1.1 billion toHSBC on March 28, 2003.
Also on March 28, 2003, we called for redemption all the issued and outstanding shares of our 5.00%cumulative preferred stock, $4.50 cumulative preferred stock and $4.30 cumulative preferred stock totaling$114 million. Pursuant to the terms of these issues of preferred stock, we paid a redemption price of $50.00 pershare of 5.00% cumulative preferred stock, $103.00 per share of $4.50 cumulative preferred stock and$100.00 per share of $4.30 cumulative preferred stock, plus, in each case, all dividends accrued and unpaid,whether or not earned or declared, to the redemption date. Additionally, on March 28, 2003, we declared adividend of $0.8694 per share on our common stock, which was paid on May 6, 2003 to our holders of recordon March 28, 2003.
In conjunction with our acquisition by HSBC, we incurred acquisition related costs of $198 million. Consistentwith the guidelines for accounting for business combinations, these costs were expensed in our statement ofincome for the period January 1 through March 28, 2003.
The purchase price paid by HSBC for our common stock plus related purchase accounting adjustments wasvalued at $14.7 billion and is recorded as ""Additional paid-in capital'' in the accompanying consolidatedbalance sheet. The purchase price was allocated to our assets and liabilities based on their estimated fairvalues at the acquisition date based, in part, on third party valuation data. During the Ñrst quarter of 2004, wemade Ñnal adjustments to the allocation of purchase price to our assets and liabilities. Since the one-yearanniversary of our acquisition by HSBC was completed during the Ñrst quarter of 2004, no further acquisition-related adjustments to the purchase price allocation will occur, except for changes in estimates for the taxbasis in our assets and liabilities or other tax estimates recorded at the date of our acquisition by HSBCpursuant to Statement of Financial Accounting Standards No. 109, ""Accounting for Income Taxes.''
Household Bank, f.s.b. During the fourth quarter of 2002, in conjunction with our eÅorts to make the mosteÇcient use of our capital and in recognition that the continued operation of Household Bank, f.s.b. (the""Thrift'') was not in our long-term strategic interest, we completed the sale of substantially all of theremaining assets and deposits of the Thrift. Disposition of Thrift assets and deposits included the sale of realestate secured receivables totaling $3.6 billion, the sale of investment securities totaling $2.2 billion and thesale of retail certiÑcates of deposit totaling $4.3 billion. A loss of $240 million (after-tax) was recorded on thedisposition of these assets and deposits.
5. Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIEC Policies
On December 29, 2004, we sold our domestic private label receivable portfolio, including the retained interestsassociated with securitized private label receivables, to HSBC Bank USA for an aggregate purchase price of$12.4 billion and recorded a gain of $663 million ($423 million after-tax). Included in this gain was the release
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of $505 million in credit loss reserves associated with the portfolio. The domestic private label receivableportfolio sold consisted of receivables with a balance of $12.2 billion ($15.6 billion on a managed basis). Thepurchase price was determined based upon an independent valuation opinion.
We retained the customer relationships and by agreement will sell additional domestic private label receivableoriginations generated under current and future private label accounts to HSBC Bank USA on a daily basis atfair market value. We will also service the receivables for HSBC Bank USA for a fee under a serviceagreement that was reviewed by the staÅ of the Board of Governors of the Federal Reserve Board (the""Federal Reserve Board''.)
Upon receipt of regulatory approval for the sale of the domestic private label receivable portfolio, we adoptedcharge-oÅ and account management policies in accordance with the Uniform Retail Credit ClassiÑcation andAccount Management Policy issued by the Federal Financial Institutions Examination Council (""FFIECPolicies'') for our domestic private label and MasterCard and Visa portfolios.
FFIEC Policies require that private label and MasterCard/Visa credit card accounts be charged-oÅ 180 daysafter becoming delinquent. For accounts involving a bankruptcy, charge-oÅ should occur by the end of themonth 60 days after notiÑcation or 180 days delinquent, whichever is sooner. Certain domestic MasterCardand Visa portfolios were following FFIEC charge-oÅ policies prior to December 2004. Domestic private labelreceivables originated through new merchant relationships after October 2002, which represented 18.8 percentof the portfolio at the sale date, were also following the 180-day charge-oÅ policy. The remainder of ourprivate label credit card receivable portfolio previously charged-oÅ receivables the month following the monthin which the account became nine months contractually delinquent. Prior to the adoption of FFIEC charge-oÅpolicies, our domestic private label portfolio recorded charge-oÅ involving a bankruptcy by the end of themonth 90 days after bankruptcy notiÑcation was received.
The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa receivablesresulted in a reduction to our net income of $121 million as summarized below:
MasterCardPrivate Label and Visa
Portfolio Portfolio Total
(in millions)
Net interest income:
Reversal of Ñnance charge income on charged-oÅ accounts(1) ÏÏÏÏÏÏ $ (45) $(1) $ (46)
Other income:
Reversal of fee income on charged-oÅ accounts(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (40) - (40)
Impact of FFIEC policies on securitized receivables(2) ÏÏÏÏÏÏÏÏÏÏÏÏ (64) (2) (66)
Provision for credit losses:
Owned charge-oÅs to comply with FFIEC policies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (155) (3) (158)
Release of owned credit loss reserves ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 116 4 120
Reductions to net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(120) $(1) $(121)
(1) Accrued Ñnance charges and fee income are reversed against the related revenue lines.
(2) Represents charge-oÅ of principal, interest and fees on securitized receivables.
The adoption of FFIEC account management policies for our domestic private label and MasterCard/Visareceivables revises existing policies regarding restructuring of past due accounts for certain receivables on a go-forward basis. Certain domestic MasterCard/Visa receivables were following these policies prior to December2004. The requirements before such accounts can now be re-aged are as follows: (a) the borrower is requiredto make three consecutive minimum monthly payments or a lump sum equivalent; (b) the account must be inexistence for a minimum of nine months; and (c) the account should not be re-aged, more than once withinany twelve-month period and not more than twice in a Ñve-year period. An account may be re-aged after it
124
enters a work-out program, including internal and third party debt counseling services, but only after receipt ofat least three consecutive minimum monthly payments or the equivalent cumulative amount, as agreed uponunder the work-out or debt management program. Re-aging for work-out purposes is limited to once in a Ñve-year period and is in addition to the once in twelve months and twice in Ñve year limits.
6. Securities
Securities consisted of the following available-for-sale investments:
Total securities available for saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $11,058 $17 $(2) $11,073
Proceeds from the sale of available-for-sale investments totaled approximately $.9 billion in 2004, $.7 billion inthe period March 29 through December 31, 2003, $.8 billion in the period January 1 through March 28, 2003and $.6 billion in 2002. We realized gross gains of $15 million in 2004, $18 million in the period March 29through December 31, 2003, $41 million in the period January 1 through March 28, 2003 and $19 million in2002. We realized gross losses of $3 million in 2004, $.4 million in the period March 29 through December 31,2003, $3 million in the period January 1 through March 28, 2003 and $12 million in 2002 on those sales.
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A summary of gross unrealized losses and related fair values as of December 31, 2004, classiÑed as to thelength of time the losses have existed is presented in the following table:
Less Than One Year Greater Than One Year
Gross Aggregate Gross AggregateNumber of Unrealized Fair Value of Number of Unrealized Fair Value of
December 31, 2004 Securities Losses Investments Securities Losses Investments
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 21 (2) 114 42 (1) 130
The gross unrealized losses on our securities available for sale have increased during 2004 due to a generalincrease in interest rates. The contractual terms of these securities do not permit the issuer to settle thesecurities at a price less than the par value of the investment. Since substantially all of these securities arerated A- or better, and because we have the ability and intent to hold these investments until maturity or amarket price recovery, these securities are not considered other-than temporarily impaired.
The amortized cost of our securities available for sale was adjusted to fair market value at the time of themerger with HSBC. As a result, at December 31, 2003, gross unrealized losses had existed less than one year.See Note 25, ""Fair Value of Financial Instruments,'' for further discussion of the relationship between the fairvalue of our assets and liabilities.
Contractual maturities of and yields on investments in debt securities were as follows:
At December 31, 2004
Due After 1 After 5Within but Within but Within After1 Year 5 Years 10 Years 10 Years Total
Amounts due and deferred from receivable salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 298 258
Total owned receivables, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 104,815 91,027
Receivables serviced with limited recourse ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14,225 26,201
Total managed receivables, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $119,040 $117,228
Purchase accounting fair value adjustments represent adjustments which have been ""pushed down'' to recordour receivables at fair value at the date of acquisition by HSBC.
On December 29, 2004, we sold our domestic private label receivable portfolio, including the retained interestsassociated with our securitized private label receivables, with an outstanding balance of $12.2 billion($15.6 billion on a managed basis) to HSBC Bank USA. We recorded an after tax gain on the sale of$423 million. See Note 5, ""Sale of Domestic Private Label Receivable Portfolio and Adoption of FFIECPolicies,'' for further discussion.
Foreign receivables included in owned receivables were as follows:
Personal non-credit card ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20,010 18,936
Commercial and otherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 317 401
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $121,080 $118,579
We maintain facilities with third parties which provide for the securitization or secured Ñnancing ofreceivables on both a revolving and non-revolving basis totaling $14.1 billion, of which $9.9 billion wereutilized at December 31, 2004. The amount available under these facilities will vary based on the timing andvolume of public securitization or secured Ñnancing transactions and our general liquidity plans.
Contractual maturities of owned receivables were as follows:
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,124 $5,851 $5,782 $5,333 $6,186 $75,579 $106,855
A substantial portion of consumer receivables, based on our experience, will be renewed or repaid prior tocontractual maturity. The above maturity schedule should not be regarded as a forecast of future cashcollections. The ratio of annual cash collections of principal on owned receivables to average principalbalances, excluding credit card receivables, approximated 39 percent in 2004 and 40 percent in 2003.
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The following table summarizes contractual maturities of owned receivables due after one year by repricingcharacteristic:
At December 31, 2004
Over 1 ButWithin Over5 Years 5 Years
(in millions)
Receivables at predetermined interest rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $17,309 $63,084
Receivables at Öoating or adjustable rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5,843 12,495
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $23,152 $75,579
Nonaccrual owned consumer receivables totaled $3.0 billion (including $432 million relating to foreignoperations) at December 31, 2004 and $3.1 billion (including $316 million relating to foreign operations) atDecember 31, 2003. Interest income that would have been recorded if such nonaccrual receivables had beencurrent and in accordance with contractual terms was approximately $377 million (including $50 millionrelating to foreign operations) in 2004 and $414 million (including $38 million relating to foreign operations)in 2003. Interest income that was included in Ñnance and other interest income prior to these loans beingplaced on nonaccrual status was approximately $197 million (including $27 million relating to foreignoperations) in 2004 and $210 million (including $18 million relating to foreign operations) in 2003. For ananalysis of reserves for credit losses on an owned and managed basis, see our ""Analysis of Credit LossReserves Activity'' in Management's Discussion and Analysis and Note 8, ""Credit Loss Reserves.''
Interest-only strip receivables are reported net of our estimate of probable losses under the recourse provisionsfor receivables serviced with limited recourse. Our estimate of the recourse obligation totaled $890 million atDecember 31, 2004 and $2,374 million at December 31, 2003. Interest-only strip receivables also included fairvalue mark-to-market adjustments which increased the balance by $76 million at December 30, 2004 and$257 million at December 31, 2003. Reductions to our interest-only strip receivables in 2004 reÖect the impactof reduced securitization levels, including our decision to structure new collateralized funding transactions assecured Ñnancings.
Amounts due and deferred from receivable sales include assets established for certain receivable sales,including funds deposited in spread accounts, and net customer payments due from (to) the securitizationtrustee.
We issued securities backed by dedicated home equity loan receivables of $3.3 billion in 2004 and 2003. In2004, we issued securities backed by dedicated auto Ñnance loan receivables of $1.8 billion. For accountingpurposes, these transactions were structured as secured Ñnancings, therefore, the receivables and the relateddebt remain on our balance sheet. Real estate secured receivables included closed-end real estate securedreceivables totaling $7.7 billion at December 31, 2004 and $8.0 billion at December 31, 2003 that secured theoutstanding debt related to these transactions. Auto Ñnance receivables totaling $2.6 billion at December 31,2004 secured the outstanding debt related to these transactions.
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8. Credit Loss Reserves
An analysis of credit loss reserves was as follows:
At December 31,
2004 2003 2002
(in millions)
Owned receivables:
Credit loss reserves at beginning of periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,793 $ 3,333 $ 2,663
Provision for credit lossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,334 3,967 3,732
Credit loss reserves for receivables serviced with limited recourse ÏÏÏÏÏÏ 890 2,374 1,759
Credit loss reserves for managed receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 4,515 $ 6,167 $ 5,092
Reductions to the provision for credit losses and overall reserve levels on receivables serviced with limitedrecourse in 2004 reÖect the impact of reduced securitization levels, including our decision to structure newcollateralized funding transactions as secured Ñnancings.
Further analysis of credit quality and credit loss reserves is presented in Item 7, ""Management's Discussionand Analysis of Financial Condition and Results of Operations'' of Form 10-K under the caption ""CreditQuality.''
9. Asset Securitizations
We have sold auto Ñnance, MasterCard and Visa, private label and personal non-credit card receivables invarious securitization transactions. We continue to service and receive servicing fees on the outstandingbalance of these securitized receivables. We also retain rights to future cash Öows arising from thesereceivables after the investors receive their contractual return. We have also, in certain cases, retained othersubordinated interests in these securitizations. These transactions result in the recording of an interest-onlystrip receivable which represents the value of the future residual cash Öows from securitized receivables. Theinvestors and the securitization trusts have only limited recourse to our assets for failure of debtors to pay.That recourse is limited to our rights to future cash Öow and any subordinated interest we retain. Servicingassets and liabilities are not recognized in conjunction with our securitizations since we receive adequatecompensation relative to current market rates to service the receivables sold. See Note 2, ""Summary ofSigniÑcant Accounting Policies,'' for further discussion on our accounting for interest-only strip receivables.
In the third quarter of 2004, we began to structure all new collateralized funding transactions as securedÑnancings. However, because existing public MasterCard and Visa credit card transactions were structured assales to revolving trusts that require replenishments of receivables to support previously issued securities,receivables will continue to be sold to these trusts until the revolving periods end, the last of which is expectedto occur in early 2008 based on current projections. After December 29, 2004, private label trusts that publiclyissued securities are now replenished by HSBC Bank USA as a result of the daily sales of new domestic
130
private label credit card originations to HSBC Bank USA. In addition, we will continue to replenish atreduced levels, certain non-public personal non-credit card and MasterCard and Visa securities issued toconduits and record the resulting replenishment gains for a period of time to manage liquidity. Since oursecuritized receivables have varying lives, it will take several years for these receivables to pay-oÅ and therelated interest-only strip receivables to be reduced to zero.
Securitization revenue includes income associated with the current and prior period securitization ofreceivables with limited recourse structured as sales. Such income includes gains on sales, net of our estimateof probable credit losses under the recourse provisions, servicing income and excess spread relating to thosereceivables.
March 29 January 1Year Ended through through Year Ended
December 31, December 31, March 28, December 31,2004 2003 2003 2002
Net replenishment gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 414 411 137 523
Servicing revenue and excess spread ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 569 481 256 1,289
Total securitization revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,008 $1,027 $434 $2,134
Our interest-only strip receivables, net of the related loss reserve and excluding the mark-to-marketadjustment recorded in accumulated other comprehensive income and, in 2004, the private label portionpurchased by HSBC Bank USA in 2004 decreased $466 million in 2004, decreased $400 million in the periodMarch 29 to December 31, 2003, decreased $30 million in the period January 1 to March 28, 2003 andincreased $199 million in 2002.
Net initial gains, which represent gross initial gains net of our estimate of probable credit losses under therecourse provisions, and the key economic assumptions used in measuring the net initial gains fromsecuritizations were as follows:
Auto MasterCard/ Private Personal Non-Year ended December 31, Finance Visa Label Credit Card Total
2004
Net initial gains (in millions) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6(2)
$ 14 $ 5 $ - $ 25
Key economic assumptions:(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Weighted-average life (in years)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2.1 .3 .4 -
Discount rate on cash Öows ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10.0 9.0 10.0 11.0
Cost of funds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4.3 3.2 3.3 2.4
(1) Weighted-average annual rates for securitizations entered into during the period for securitizations of loans with similar
characteristics.(2) In 2004, auto Ñnance was involved in a securitization which later was restructured as a secured Ñnancing. The initial gain reÖected
above was the gain on the initial transaction that remained after the securitization was restructured, as required under Emerging Issues
Task Force Issue No. 02-9.
Certain securitization trusts, such as credit cards, are established at Ñxed levels and require frequent sales ofnew receivables into the trust to replace receivable run-oÅ. These replenishments totaled $30.3 billion in 2004,$30.9 billion in 2003 and $26.1 billion in 2002. Net gains (gross gains, less estimated credit losses under therecourse provisions) related to these replenishments were calculated using weighted-average assumptionsconsistent with those used for calculating gains on initial securitizations and totaled $414 million in 2004,$548 million in 2003, $523 million in 2002.
Cash Öows received from securitization trusts were as follows:
Real Estate Auto MasterCard/ Private Personal Non-Year ended December 31, Secured Finance Visa Label Credit Card Total
(in millions)
2004
Proceeds from initialsecuritizations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ -
(2)$ 550 $ 190 $ - $ 740
Servicing fees received ÏÏÏÏÏÏÏÏÏÏ 1 86 185 93 161 526
Servicing fees received ÏÏÏÏÏÏÏÏÏÏ 7 103 203 58 114 485
Other cash Öow received onretained interests(1) ÏÏÏÏÏÏÏÏÏÏÏ 36 174 911 215 184 1,520
(1) Other cash Öows include all cash Öows from interest-only strip receivables, excluding servicing fees.
(2) In 2004, auto Ñnance was involved in a securitization which was later restructured as a secured Ñnancing. These transactions are
reported net in the table above.
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At December 31, 2004, the sensitivity of the current fair value of the interest-only strip receivables to animmediate 10 percent and 20 percent unfavorable change in assumptions are presented in the table below.These sensitivities are based on assumptions used to value our interest-only strip receivables at December 31,2004.
Real Estate Auto MasterCard/ Personal Non-Secured Finance Visa Private Label Credit Card
(dollars are in millions)
Carrying value (fair value) of interest-only strip receivables ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 1 $ 36 $162 $ - $124
Weighted-average life (in years) ÏÏÏÏÏÏÏ .3 1.6 .5 - .9
Impact on fair value of 10% adversechange ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $ - $ (6) $ - $(10)
Impact on fair value of 20% adversechange ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ - - (13) - (20)
These sensitivities are hypothetical and should not be considered to be predictive of future performance. Asthe Ñgures indicate, the change in fair value based on a 10 percent variation in assumptions cannot necessarilybe extrapolated because the relationship of the change in assumption to the change in fair value may not belinear. Also, in this table, the eÅect of a variation in a particular assumption on the fair value of the residualcash Öow is calculated independently from any change in another assumption. In reality, changes in one factormay contribute to changes in another (for example, increases in market interest rates may result in lowerprepayments) which might magnify or counteract the sensitivities. Furthermore, the estimated fair values asdisclosed should not be considered indicative of future earnings on these assets.
Static pool credit losses are calculated by summing actual and projected future credit losses and dividing themby the original balance of each pool of asset. Due to the short term revolving nature of MasterCard and Visareceivables, the weighted-average percentage of static pool credit losses is not considered to be materiallydiÅerent from the weighted-average charge-oÅ assumptions used in determining the fair value of our interest-only strip receivables in the table above. At December 31, 2004, static pool credit losses for auto Ñnance loanssecuritized in 2003 were estimated to be 10.2 percent and for auto Ñnance loans securitized in 2002 wereestimated to be 14.7 percent.
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Receivables and two-month-and-over contractual delinquency for our managed and serviced with limitedrecourse portfolios were as follows:
(1) Includes our liquidating legacy Ñrst and reverse mortgage portfolios.(2) The adoption of FFIEC charge-oÅ policies for our domestic private label and MasterCard/Visa portfolios in December 2004 increased
managed basis net charge-oÅ by 2 basis points for MasterCard/Visa and 112 basis points for private label receivables and increased
receivables serviced with limited recourse net charge-oÅs by 2 basis points for MasterCard/Visa and 94 basis points for private label
receivables and increased owned consumer net charge-oÅs by 16 basis points.
10. Intangible Assets
Intangible assets consisted of the following:
Accumulated CarryingDecember 31, 2004 Gross Amortization Value
(in millions)
Purchased credit card relationships and related programs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,723 $355 $1,368
Technology, customer lists and other contracts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 281 26 255
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,106 $250 $2,856
During the third quarter of 2004, we completed our annual impairment test of intangible assets anddetermined that the fair value of each intangible asset exceeded its carrying value. As a result, we concludedthat none of our intangible assets are impaired.
Weighted-average amortization periods for our intangible assets as of December 31, 2004 were as follows:
(in months)
Purchased credit card relationships and related programs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 80
Intangible amortization expense totaled $363 million in 2004, $246 million in the period March 29 throughDecember 31, 2003, $12 million in the period January 1 through March 28, 2003 and $58 million in 2002.
The trade names are not subject to amortization as we believe they have inÑnite lives. The remaining acquiredintangibles are being amortized to their residual values over their estimated useful lives either on a straight-line basis or in proportion to the underlying revenues generated. These useful lives range from 5 years for retailservices merchant relationships to approximately 10 years for certain loan related relationships. Our purchasedcredit card relationships have estimated residual values of $210 million as of December 31, 2004.
Estimated amortization expense associated with our intangible assets for each of the following years is asfollows:
As a result of push-down accounting, goodwill of approximately $6.9 billion has been recorded. As discussedin Note 4, ""Acquisitions and Divestitures,'' during the Ñrst quarter of 2004, we made Ñnal adjustments to thepurchase price allocation resulting from our acquisition by HSBC. No further acquisition-related adjustmentsto our goodwill balance will occur, except for changes in estimates of the tax basis in our assets and liabilitiesor other tax estimates recorded at the date of our acquisition by HSBC, pursuant to Statement of FinancialAccounting Standards, No. 109, ""Accounting for Income Taxes.'' Goodwill balances associated with ourforeign businesses will also change from period to period due to movements in foreign exchange. Goodwill
136
established as a result of the acquisition has not been allocated to or included in the reported results of ourreportable segments, which is consistent with management's view of our reportable segment results.
Changes in the carrying amount of goodwill during 2004 are as follows:
(in millions)
Balance as of January 1, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,697
Final adjustments to HSBC purchase price allocation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 141
Change in estimate of the tax basis of assets and liabilities recorded in the HSBC mergerÏÏ (56)
Impact of foreign currency translationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 74
Balance at December 31, 2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,856
During the third quarter of 2004, we completed our annual impairment test of goodwill. For purposes of thistest, we assigned the goodwill to our reporting units. The fair value of each of the reporting units to whichgoodwill was assigned exceeded its carrying value. As a result, we concluded that none of our goodwill isimpaired.
Accumulated depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 168 101
Properties and equipment, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $487 $527
As a result of our merger with HSBC, the amortized cost of our property and equipment was adjusted to fairmarket value and accumulated depreciation and amortization on a ""predecessor'' basis was eliminated at thetime of the merger.
Depreciation and amortization expense totaled $127 million in 2004, $101 million in the period March 29through December 31, 2003, $33 million in the period January 1 through March 28, 2003 and $139 million in2002.
13. Deposits
The following table shows foreign deposits at December 31, 2004. There were no domestic deposits atDecember 31, 2004 or December 31, 2003.
At December 31,
2004 2003
Weighted- Weighted-Average Average
Amount Rate Amount Rate
(dollars are in millions)
Time certiÑcates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $12 5.3% $169 3.6%
Total foreign deposits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 88 1.9 991 3.5 595 3.7
Total depositsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $88 1.9% $992 3.5% $5,839 6.5%
In conjunction with the fourth quarter 2002 sale of substantially all of the assets and deposits of the Thrift, wesold $4.3 billion in domestic deposits. The remaining domestic deposits were sold in the Ñrst quarter of 2003.
Interest expense on total deposits was $2 million in 2004, $28 million in the period March 29 throughDecember 31, 2003, $8 million in the period January 1 through March 28, 2003 and $380 million in 2002.Interest expense on domestic deposits was zero in 2004, insigniÑcant in 2003 and $358 million in 2002.
Maturities of time certiÑcates in amounts of $100,000 or more at December 31, 2004, all of which wereforeign, were:
(in millions)
3 months or less ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2
Over 3 months through 6 months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ -
Over 6 months through 12 months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ -
Over 12 months ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $12
Contractual maturities of time certiÑcates within each interest rate range at December 31, 2004 were asfollows:
Interest Rate 2005 2006 2007 2008 2009 Thereafter Total
Average borrowings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6,830 1,473 8,303
Weighted-average interest rate:
At year-endÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.8% 3.9% 2.4%
Paid during year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.9 3.4 2.2
Commercial paper included obligations of foreign subsidiaries of $248 million at December 31, 2004,$307 million at December 31, 2003 and $497 million at December 31, 2002. Bank and other borrowingsincluded obligations of foreign subsidiaries of $44 million at December 31, 2004, $832 million at Decem-ber 31, 2003 and $1.5 billion at December 31, 2002.
Interest expense for commercial paper, bank and other borrowings totaled $211 million in 2004, $130 millionin the period March 29 through December 31, 2003, $19 million in the period January 1 through March 28,2003 and $181 million in 2002.
We maintain various bank credit agreements primarily to support commercial paper borrowings and also toprovide funding in the U.K. We had committed back-up lines and other bank lines of $18.0 billion atDecember 31, 2004, including $10.1 billion with HSBC and subsidiaries and $15.8 billion at December 31,2003, including $7.0 billion with HSBC and subsidiaries. Our U.K. subsidiary had drawn $7.4 billion on itsbank lines of credit (all with HSBC), at December 31, 2004 and had $4.1 billion drawn on its bank lines ofcredit including $3.4 billion drawn on HSBC lines, at December 31, 2003. A $4.0 billion revolving creditfacility with HSBC Private Bank (Suisse) SA, which was new in 2004 to allow temporary increases incommercial paper issuances in anticipation of the sale of the private label receivables to HSBC Bank USA,expired on December 30, 2004. Formal credit lines are reviewed annually and expire at various dates through2007. Borrowings under these lines generally are available at a surcharge over LIBOR. The most restrictiveÑnancial covenant contained in the back-up line agreements that could restrict availability is an obligation tomaintain minimum shareholder's equity of $6.9 billion which is substantially below our December 31, 2004common and preferred shareholder's(s') equity balance of $16.9 billion. Because our U.K. subsidiary receivesits funding directly from HSBC, we eliminated all third-party back-up lines at our U.K. subsidiary in 2004.Annual commitment fee requirements to support availability of these lines at December 31, 2004 totaled$7 million and included $2 million for the HSBC lines.
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15. Long Term Debt (With Original Maturities Over One Year)
Purchase Accounting Fair Value Adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,274 3,189
Total long term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $85,378 $79,632
Purchase accounting fair value adjustments represent adjustments which have been ""pushed down'' to recordour long term debt at fair value at the merger date.
Secured Ñnancings of $7.3 billion at December 31, 2004 are secured by $10.3 billion of real estate secured andauto Ñnance receivables. Secured Ñnancings of $6.7 billion at December 31, 2003 are secured by $8.0 billion ofreal estate secured receivables.
At December 31, 2004, long term debt included carrying value adjustments relating to derivative Ñnancialinstruments which decreased the debt balance by $121 million and a foreign currency translation adjustmentrelating to our foreign denominated debt which increased the debt balance by $4 billion. At December 31,2003, long term debt included carrying value adjustments relating to derivative Ñnancial instruments whichincreased the debt balance by $37 million and a foreign currency translation adjustment relating to our foreigndenominated debt which increased the debt balance by $3.3 billion.
Weighted-average interest rates were 5.1 percent at December 31, 2004 and 5.1 percent at December 31, 2003(excluding purchase accounting adjustments). Interest expense for long term debt was $2.6 billion in 2004,
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$1.8 billion in the period March 29 through December 31, 2003, $870 million in the period January 1 throughMarch 28, 2003 and $3.3 billion in 2002. The most restrictive Ñnancial covenants contained in the terms of ourdebt agreements are the maintenance of a minimum shareholder's equity of $6.9 billion which is substantiallylower than our common and preferred shareholder's equity balance of $16.9 billion at December 31, 2004.Debt denominated in a foreign currency is included in the applicable rate category based on the eÅectiveU.S. dollar equivalent rate as summarized in Note 16, ""Derivative Financial Instruments.''
In 2002, we issued $542 million of 8.875 percent Adjustable Conversion-Rate Equity Security Units. TheAdjustable Conversion-Rate Equity Security Units each consist of a senior unsecured note of HSBC FinanceCorporation (as successor by merger to Household Finance Corporation) in the principal amount of $25 and acontract to purchase, for $25, between 2.6041 and 3.1249 HSBC ordinary shares, depending on the marketvalue at the time, on February 15, 2006 or 2.6041 HSBC ordinary shares if early settlement is elected by theholder. The senior unsecured notes will mature on February 15, 2008. The net proceeds from the sale of theunits were allocated between the purchase contracts and the senior unsecured notes in our balance sheet basedon the fair value of each at the date of the oÅering. During 2004, .6 million stock purchase contracts wereexercised. During 2003, 20 million stock purchase contracts were exercised. At December 31, 2004,unexercised stock purchase contracts totaled 1.4 million.
The following table summarizes our junior subordinated notes issued to capital trusts (""Junior SubordinatedNotes'') and the related company obligated mandatorily redeemable preferred securities (""PreferredSecurities''):
Household Capital Household Capital Household CapitalTrust VII Trust VI Trust V
(""HCT VII'') (""HCT VI'') (""HCT V'')
(dollars are in millions)
Junior Subordinated Notes:
Principal balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 206.2 $ 206.2 $ 309.3
Face value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 200 $ 200 $ 300
Issue date ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ November 2001 January 2001 June 2000
As of December 31, 2003, we adopted FASB Interpretation Number 46, ""Consolidation of Variable InterestEntities'', as revised in December 2003. Upon adoption, we deconsolidated all of the previously establishedcapital trust entities which issued common securities to HSBC Finance Corporation and preferred securitiesto third parties. These trusts invested the proceeds of those oÅerings in junior subordinated notes ofHSBC Finance Corporation. As a result of the deconsolidation of those trusts, we report the JuniorSubordinated Notes on our balance sheet.
The Preferred Securities must be redeemed when the Junior Subordinated Notes are paid. The JuniorSubordinated Notes have a stated maturity date, but are redeemable by us, in whole or in part, beginning onthe dates indicated above at which time the Preferred Securities are callable at par ($25 per PreferredSecurity) plus accrued and unpaid dividends. Dividends on the Preferred Securities are cumulative, payablequarterly in arrears, and are deferrable at our option for up to Ñve years. We cannot pay dividends on ourpreferred and common stocks during such deferments. The Preferred Securities have a liquidation value of$25 per preferred security.
Our obligations with respect to the Junior Subordinated Notes, when considered together with certainundertakings of HSBC Finance Corporation with respect to the Trusts, constitute full and unconditionalguarantees by us of the Trusts' obligations under the respective Preferred Securities.
141
Maturities of long term debt at December 31, 2004 were as follows:
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $85,378
Certain components of our long term debt may be redeemed prior to its stated maturity.
16. Derivative Financial Instruments
Our business activities involve analysis, evaluation, acceptance and management of some degree of risk orcombination of risks. Accordingly, we have comprehensive risk management policies to address potentialÑnancial risks, which include credit risk (which includes counterparty credit risk), liquidity risk, market risk,and operational risks. Our risk management policy is designed to identify and analyze these risks, to setappropriate limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. Our risk management policies are primarily carried out inaccordance with practice and limits set by the HSBC Group Management Board. The HSBC FinanceCorporation Asset Liability Committee (""ALCO'') meets regularly to review risks and approve appropriaterisk management strategies within the limits established by the HSBC Group Management Board and ourBoard of Directors. In accordance with the policies and strategies established by ALCO, in the normal courseof business, we enter into various transactions involving derivative Ñnancial instruments. These derivativeÑnancial instruments primarily are used to manage our market risk and counterparty credit risk. For furtherinformation on our strategies for managing interest rate and foreign exchange rate risk, see the ""RiskManagement'' section within our Management's Discussion and Analysis of Financial Condition and Resultsof Operations.
Objectives for Holding Derivative Financial Instruments Market risk (which includes interest rate and foreigncurrency exchange risks) is the possibility that a change in interest rates or foreign exchange rates will cause aÑnancial instrument to decrease in value or become more costly to settle. We try to manage this risk byborrowing money with similar interest rate and maturity proÑles; however, there are instances when thiscannot be achieved. Over time, customer demand for our receivable products shifts between Ñxed rate andÖoating rate products, based on market conditions and preferences. These shifts in loan products result indiÅerent funding strategies and produce diÅerent interest rate risk exposures. We maintain an overall riskmanagement strategy that uses a variety of interest rate and currency derivative Ñnancial instruments tomitigate our exposure to Öuctuations caused by changes in interest rates and currency exchange rates. Wemanage our exposure to interest rate risk primarily through the use of interest rate swaps, but also useforwards, futures, options, and other risk management instruments. We manage our exposure to foreigncurrency exchange risk primarily through the use of currency swaps, options and forwards. We do not useleveraged derivative Ñnancial instruments for interest rate risk management.
Interest rate swaps are contractual agreements between two counterparties for the exchange of periodicinterest payments generally based on a notional principal amount and agreed-upon Ñxed or Öoating rates. Themajority of our interest rate swaps are used to manage our exposure to changes in interest rates by convertingÖoating rate assets or debt to Ñxed rate or by converting Ñxed rate assets or debt to Öoating rate. We have alsoentered into currency swaps to convert both principal and interest payments on debt issued from one currencyto the appropriate functional currency.
Forwards and futures are agreements between two parties, committing one to sell and the other to buy aspeciÑc quantity of an instrument on some future date. The parties agree to buy or sell at a speciÑed price in
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the future, and their proÑt or loss is determined by the diÅerence between the arranged price and the level ofthe spot price when the contract is settled. We have used both interest rate and foreign exchange rate forwardcontracts as well as interest rate futures contracts. We use foreign exchange rate forward contracts to reduceour exposure to foreign currency exchange risk. Interest rate forward and futures contracts are used to hedgeresets of interest rates on our Öoating rate assets and liabilities. Cash requirements for forward contractsinclude the receipt or payment of cash upon the sale or purchase of the instrument.
Purchased options grant the purchaser the right, but not the obligation, to either purchase or sell a Ñnancialinstrument at a speciÑed price within a speciÑed period. The seller of the option has written a contract whichcreates an obligation to either sell or purchase the Ñnancial instrument at the agreed-upon price if, and when,the purchaser exercises the option. We use caps to limit the risk associated with an increase in rates and Öoorsto limit the risk associated with a decrease in rates.
Credit Risk By utilizing derivative Ñnancial instruments, we are exposed to counterparty credit risk.Counterparty credit risk is our primary exposure on our interest rate swap portfolio. Counterparty credit risk isthe risk that the counterparty to a transaction fails to perform according to the terms of the contract. Wecontrol the counterparty credit (or repayment) risk in derivative instruments through established creditapprovals, risk control limits, collateral, and ongoing monitoring procedures. Our exposure to credit risk forfutures is limited as these contracts are traded on organized exchanges. Each day, changes in futures contractvalues are settled in cash. In contrast, swap agreements and forward contracts have credit risk relating to theperformance of the counterparty. Beginning in the third quarter of 2003, we began utilizing an aÇliate, HSBCBank USA, as the primary provider of new domestic derivative products. We have never suÅered a loss due tocounterparty failure.
At December 31, 2004, most of our existing derivative contracts are with HSBC subsidiaries, making themour primary counterparty in derivative transactions. Most swap agreements require that payments be made to,or received from, the counterparty when the fair value of the agreement reaches a certain level. Generally,third-party swap counterparties provide collateral in the form of cash which are recorded in our balance sheetas derivative related liabilities and totaled $.4 billion at December 31, 2004. AÇliate swap counterpartiesgenerally provide collateral in the form of securities which are not recorded on our balance sheet and totaled$2.2 billion at December 31, 2004. At December 31, 2004, we had derivative contracts with a notional value ofapproximately $71.6 billion, including $61.3 billion outstanding with HSBC Bank USA. Derivative Ñnancialinstruments are generally expressed in terms of notional principal or contract amounts which are much largerthan the amounts potentially at risk for nonpayment by counterparties.
Fair Value and Cash Flow Hedges To manage our exposure to changes in interest rates, we enter into interestrate swap agreements and currency swaps which have been designated as fair value or cash Öow hedges underSFAS 133. The critical terms of interest rate swaps are designed to match those of the hedged items in orderto enable, where possible, the application of the shortcut method of accounting as deÑned by SFAS 133. Priorto the acquisition by HSBC, the majority of our fair value and cash Öow hedges were eÅective hedges whichqualiÑed for the shortcut method of accounting. Under the Financial Accounting Standards Board'sinterpretations of SFAS 133, the shortcut method of accounting was no longer allowed for interest rate swapswhich were outstanding at the time of the HSBC merger. As a result of the acquisition, we were required toreestablish and formally document the hedging relationship associated with all of our fair value and cash Öowhedging instruments and assess the eÅectiveness of each hedging relationship, both at inception of the mergerand on an ongoing basis. As a result of deÑciencies in our contemporaneous hedge documentation at the timeof acquisition, we lost the ability to apply hedge accounting to our entire cash Öow and fair value hedgingportfolio that existed at the time of merger. Substantially all derivative Ñnancial instruments entered intosubsequent to the acquisition qualify as eÅective hedges under SFAS 133. The discontinuation of hedgeaccounting on our fair value and cash Öow hedging instruments outstanding at the time of the merger, coupledwith the loss of hedge accounting on certain post merger fair value swaps, collectively increased net income by$175 million in 2004 and decreased net income by $62 million for the period March 29, 2003 throughDecember 31, 2003.
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As of December 31, 2004, 77 percent of our interest rate swap portfolio (based on notional amounts eligiblefor hedge accounting) was accounted for using the shortcut method, which represents 64 percent of our entireinterest rate swap portfolio. To the extent that the critical terms of the hedged item and the derivative are notidentical, hedge ineÅectiveness is reported in earnings during the current period in other revenues as acomponent of derivative income. Although the critical terms of currency swaps designated as eÅective hedgesare designed to match those of the hedged items, SFAS 133 does not allow shortcut method accounting forthis type of hedge. Therefore, there is ineÅectiveness which is reported in current period earnings.
Fair value hedges include interest rate swaps which convert our Ñxed rate debt to variable rate debt andcurrency swaps which convert debt issued from one currency into pay variable debt of the appropriatefunctional currency. Hedge ineÅectiveness associated with fair value hedges is recorded in other revenues asderivative income and was a gain of $.6 million ($.4 million after tax) in 2004, a restated gain of $.8 million($.5 million after tax) in the period March 29 through December 31, 2003, a gain of $3 million ($2 millionafter tax) in the period January 1 through March 28, 2003 and a loss of $5 million ($3 million after tax) in2002. All of our fair value hedges were associated with debt during 2004, 2003 and 2002. We recorded fairvalue adjustments for unexpired fair value hedges which decreased the carrying value of our debt by$60 million at December 31, 2004 and increased the carrying value of our debt by $122 million (restated) atDecember 31, 2003. Fair value adjustments for unexpired fair value hedges on a ""predecessor'' basis areincluded in the purchase accounting fair value adjustment to debt as a result of push-down accountingeÅective March 29, 2003 when the ""successor'' period began.
Cash Öow hedges include interest rate swaps which convert our variable rate debt or assets to Ñxed rate debt orassets and currency swaps which convert debt issued from one currency into pay Ñxed debt of the appropriatefunctional currency. Gains and (losses) on derivative instruments designated as cash Öow hedges (net of tax)are reported in accumulated other comprehensive income and totaled a gain of $119 million at December 31,2004 and a restated loss of $11 million at December 31, 2003. Accumulated other comprehensive income on a""predecessor'' basis was eliminated as a result of push-down accounting eÅective March 29, 2003 when the""successor'' period began. We expect $54 million ($34 million after tax) of currently unrealized net gains willbe reclassiÑed to earnings within one year, however, these unrealized gains will be oÅset by increased interestexpense associated with the variable cash Öows of the hedged items and will result in no net economic impactto our earnings. Hedge ineÅectiveness associated with cash Öow hedges is recorded in other revenues asderivative income and was immaterial in 2004 and was a restated gain of $.5 million ($.3 million after tax) inthe period March 29 through December 31, 2003. Hedge ineÅectiveness associated with cash Öow hedges wasimmaterial for the period January 1 through March 28, 2003 and in 2002.
At December 31, 2004, $4.0 billion of derivative instruments, at fair value, were recorded in derivativeÑnancial assets and $70 million in derivative related liabilities. At December 31, 2003, $3.0 billion ofderivative instruments, at fair value, were recorded in derivative Ñnancial assets and $149 million in derivativerelated liabilities.
Information related to deferred gains and losses on terminated derivatives was as follows:
Increases (decreases) to carrying values resulting from net deferred gains andlosses:
Long term debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (61) $ (84)
Accumulated other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 103 -
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Amortization of net deferred gains (losses) totaled ($23) million in 2004, ($7) million in the period March 29through December 31, 2003 (restated), $80 million in the period January 1 through March 28, 2003 and$156 million in 2002.
Hedges of Net Investments in Foreign Operations Prior to the merger with HSBC, we used forward-exchangecontracts and foreign currency options to hedge our net investments in foreign operations. We used thesehedges to protect against adverse movements in exchange rates. Net gains and (losses) (net of tax) related tothese derivatives were included in accumulated other comprehensive income and totaled $.1 million in theperiod March 29 through December 31, 2003 (restated) for the contracts that terminated subsequent to themerger with HSBC, ($12) million in the period January 1 through March 28, 2003 and $(86) million in 2002.We have not entered into foreign exchange contracts to hedge our investment in foreign subsidiaries since ourmerger with HSBC.
Non-Qualifying Hedging Activities We may also use forward rate agreements, interest rate caps, exchangetraded futures, and interest rate and currency swaps which are not designated as hedges under SFAS 133,either because they do not qualify as eÅective hedges or because we lost the ability to apply hedge accountingfollowing our acquisition by HSBC as discussed above. These Ñnancial instruments are economic hedges butdo not qualify for hedge accounting and are primarily used to minimize our exposure to changes in interestrates and currency exchange rates. Unrealized and realized gains (losses) on derivatives which were notdesignated as hedges are reported in other revenues as derivative income and totaled $510 million($324 million after tax) in 2004; $283 million ($180 million after tax) in the period March 29, 2003 throughDecember 31, 2003 (restated); $(1) million ($(.7) million after tax) in the period January 1 throughMarch 28, 2003 and $8 million ($5 million after tax) in 2002.
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Derivative Financial Instruments The following table summarizes derivative Ñnancial instrument activity:
(1) Represent contracts terminated as the market execution technique of closing the transaction either (a) just prior to maturity to avoid delivery of the
underlying instrument or (b) at the maturity of the underlying items being hedged.
(2) Under the Financial Accounting Standards Board's interpretations of SFAS 133, the shortcut method of accounting was no longer allowed for
interest rate swaps which were outstanding at the time of the merger. During 2003, we restructured our interest rate swap portfolio to regain use of
the shortcut method for a substantial number of our fair value hedges and to reduce the potential volatility of future earnings.
(3) (Bracketed) unbracketed amounts represent amounts to be (paid) received by us had these positions been closed out at the respective balance sheet
date. Bracketed amounts do not necessarily represent risk of loss as the fair value of the derivative Ñnancial instrument and the items being hedged
must be evaluated together. See Note 25, ""Fair Value of Financial Instruments,'' for further discussion of the relationship between the fair value of
our assets and liabilities.
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We operate in three functional currencies, the U.S. dollar, the British pound and the Canadian dollar. TheU.S. dollar is the functional currency for exchange-traded interest rate futures contracts and options. Non-exchange traded instruments are restated in U.S. dollars by country as follows:
Interest RateForeign ExchangeInterest Forward Other RiskRate ContractsRate Currency Contracts Management
Swaps Swaps Purchased Sold Purchased Instruments
(in millions)
2004
United StatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $42,365 $17,543 $1,146 $ (599) $ - $4,345
Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 582 - - (15) 374 -
United Kingdom ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,306 607 - - - 35
$45,253 $18,150 $1,146 $ (614) $374 $4,380
2003
United StatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $39,653 $14,995 $1,223 $ (593) $ - $6,595
Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 405 - - (1) 174 -
United Kingdom ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,254 1,543 - - - 32
$41,312 $16,538 $1,223 $ (594) $174 $6,627
2002
United StatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $42,682 $10,211 $ 351 $(2,524) $ - $7,194
Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 270 - - - 159 -
United Kingdom ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,554 1,450 26 - - 27
$44,506 $11,661 $ 377 $(2,524) $159 $7,221
The table below reÖects the items hedged using derivative Ñnancial instruments which qualify for hedgeaccounting at December 31, 2004. The critical terms of the derivative Ñnancial instruments have beendesigned to match those of the related asset or liability.
The Öoating rates that we pay or receive are based on spot rates from independent market sources for the indexcontained in each interest rate swap contract, which generally are based on either 1, 3 or 6-month LIBOR.These current Öoating rates are diÅerent than the Öoating rates in eÅect when the contracts were initiated.Changes in spot rates impact the variable rate information disclosed above. However, these changes in spotrates also impact the interest rate on the underlying assets or liabilities. We use derivative Ñnancialinstruments as either qualifying hedging instruments under SFAS 133 or economic hedges to hedge thevolatility of earnings resulting from changes in interest rates on the underlying hedged items. Use of interestrate swaps which qualify as eÅective hedges under SFAS 133 increased our net interest income by 77 basispoints in 2004, 64 basis points in 2003 and 31 basis points in 2002.
17. Income Taxes
Total income taxes were:
March 29 January 1Year ended through through Year ended
December 31, December 31, March 28, December 31,2004 2003 2003 2002
(Restated)(in millions)
Provision for income taxes related to operationsÏÏÏÏÏ $1,000 $690 $182 $695
Income taxes related to adjustments included incommon shareholder's(s') equity:
Provision for U.S. income taxes had not been made on net undistributed earnings of foreign subsidiaries of$643 million at December 31, 2004 and $604 million at December 31, 2003. Determination of the amount ofunrecognized deferred tax liability related to investments in foreign subsidiaries is not practicable.
On October 22, 2004, the American Jobs Creation Act (the ""AJCA'') was signed into law. The AJCAincludes a deduction of 85% of certain foreign earnings that are repatriated, as deÑned in the AJCA. We mayelect to apply this provision to qualifying earnings repatriations in 2005. We have started an evaluation of theeÅects of the repatriation provision; however, we do not expect to be able to complete this evaluation untilafter Congress or the Treasury Department provide additional clarifying language on key elements of theprovision. We expect to complete our evaluation of the eÅects of the repatriation provision within a reasonableperiod of time following the publication of the additional clarifying language. The range of possible amountsthat we are considering for repatriation under this provision is between $0 and $500 million. The relatedpotential range of income tax is between $0 and $30 million.
In addition, provision for U.S. income taxes had not been made at December 31, 2004 on $80 million ofundistributed, untaxed earnings of our life insurance subsidiary's accumulated in its Policyholders' SurplusAccount under tax laws in eÅect prior to 1984. This amount would generally be subject to taxation in the eventour life insurance subsidiary made distributions in excess of its Shareholders' Surplus Account (generallyundistributed accumulated after-tax earnings) and certain other events. If our life insurance subsidiary weresubject to tax on the full amount of its Policyholders' Surplus Account, the additional income tax payablewould be approximately $28 million. Unlike prior law provisions which treated distributions by a life insurancecompany as Ñrst coming out of its Shareholders' Surplus Account and then out of its Policyholders' SurplusAccount, the AJCA contains provisions that would reverse such order and treat distributions as Ñrst comingout of Policyholders' Surplus Account and then Shareholders' Surplus Account. These new provisions alsoeliminate the imposition of the income tax on any such distributions from a Policyholders' Surplus Account.Such provisions apply only to distributions made by a life insurance company after December 31, 2004 andbefore January 1, 2007. At this time, management is evaluating the provisions of this law and is expecting touse these provisions to eliminate some, if not all, of the Policyholders' Surplus Account of our life insurancesubsidiary.
Household Bank, f.s.b., our U.S. savings and loan subsidiary which was disposed of in the fourth quarter of2002, previously had credit loss reserves for tax purposes that arose in years beginning before December 31,1987 in the amount of $55 million. A deferred tax liability was not established previously since we did notexpect the amount to become taxable in the future. However, the sale of substantially all of its assets anddeposits in 2002 caused this amount to become taxable resulting in a $20 million tax liability.
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At December 31, 2004, we had net operating loss carryforwards of $865 million for state tax purposes whichexpire as follows: $320 million in 2005-2009; $145 million in 2010-2014; $305 million in 2015-2019 and$95 million in 2020-2024.
Temporary diÅerences which gave rise to a signiÑcant portion of deferred tax assets and liabilities were asfollows:
Total deferred tax assets net of valuation allowance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,315 3,235
Net deferred tax liability (asset) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 147 $ (127)
During 2004, a review of the deferred tax balances was completed and, as a result, the 2003 deferred tax assetsand liabilities were realigned with their underlying tax and Ñnancial accounting basis diÅerences. Additionally,an increase to total 2003 deferred tax assets of $6 million was recorded with a reduction to goodwill.
18. Preferred Stock
In conjunction with the HSBC merger, our 7.625%, 7.60%, 7.50% and 8.25% preferred stock was convertedinto the right to receive cash which totaled approximately $1.1 billion. In consideration of HSBC transferringsuÇcient funds to make these payments, we issued the Series A cumulative preferred stock to HSBC onMarch 28, 2003. Also on March 28, 2003, we called for redemption our $4.30, $4.50 and 5.00% preferredstock.
As of December 31, 2004, there were 1,100 shares of the Series A cumulative preferred stock outstanding.Through a series of transactions which concluded in October 2004, the Series A preferred shares weretransferred from HSBC HINO. See Note 20, ""Related Party Transactions,'' for further discussion. Dividendsare cumulative and payable annually at a rate of 6.5 percent. The Series A preferred stock may be redeemed atour option after March 31, 2008. The redemption and liquidation value is $1 million per share plus accruedand unpaid dividends. The holder of the Series A preferred stock is entitled to payment before any capitaldistribution is made to the common shareholder and is entitled to vote with the holder of our common stock onmatters including the dissolution, liquidation or sale of our assets or business.
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19. Accumulated Other Comprehensive Income
As a result of push-down accounting resulting from our merger with HSBC, the balances associated with thecomponents of accumulated other comprehensive income (loss) on a ""predecessor'' basis were eliminatedeÅective March 28, 2003 when the ""successor'' period began. Accumulated other comprehensive income(loss) includes the following:
December 31, December 31, March 28, December 31, December 31,2004 2003 2003 2002 2001
Other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 200 $ Ì $ 200
20. Related Party Transactions
In the normal course of business, we conduct transactions with HSBC and its subsidiaries. These transactionsinclude funding arrangements, purchases and sales of receivables, servicing arrangements, informationtechnology services, item and statement processing services, banking and other miscellaneous services. The
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following tables present related party balances and the income and (expense) generated by related partytransactions:
At December 31,
2004 2003
(in millions)
Assets, (Liabilities) and Equity:
Derivative Ñnancial assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 3,297 $ 1,789
Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 604 1
Due to aÇliates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (13,789) (7,589)
Other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (168) (26)
Other income from HSBC aÇliates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 -
The notional value of derivative contracts outstanding with HSBC subsidiaries totaled $62.6 billion atDecember 31, 2004 and $39.7 billion at December 31, 2003. AÇliate swap counterparties have providedcollateral in the form of securities which are not recorded on our balance sheet and totaled $2.2 billion atDecember 31, 2004 and $.5 billion at December 31, 2003.
During the second quarter of 2004, we made advances to our immediate parent, HINO, totaling $266 millionwhich were repaid during the third quarter of 2004.
During the third quarter of 2004 we extended a line of credit of $1 billion to HSBC USA, Inc. During thefourth quarter of 2004, we increased the available balance on the line of credit to $2 billion. The balanceoutstanding under the line of credit at December 31, 2004 was $604 million and is included in other assets.Interest income associated with this line of credit is recorded in interest income and reÖected as interestincome on HSBC USA, Inc. advances in the table above.
Due to aÇliates includes amounts owed to subsidiaries of HSBC (other than preferred stock). This fundingwas at interest rates (both the underlying benchmark rate and credit spreads) comparable to third-party ratesfor debt with similar maturities.
At December 31, 2004, we had revolving credit facilities of $2.5 billion from HSBC domestically and$7.5 billion from HSBC in the U.K., which was increased to $8.0 billion in January 2005. A $4.0 billiondomestic revolving credit facility with HSBC Private Bank (Suisse) SA, which was new in 2004, expired onDecember 30, 2004. As of December 31, 2004, $7.4 billion was outstanding under the U.K. lines and nobalances were outstanding on the domestic lines. As of December 31, 2003, $3.4 billion was outstanding on theU.K. lines and no balances were outstanding on the domestic lines. Annual commitment fee requirements to
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support availability of these lines totaled $2 million in 2004 and $2 million in 2003 and are included as acomponent of interest expense.
In the Ñrst quarter of 2004, we sold approximately $.9 billion of real estate secured receivables from ourmortgage services business to HSBC Bank USA and recorded a pre-tax gain of $15 million on the sale. Undera separate servicing agreement, we have agreed to service all real estate secured receivables sold to HSBCBank USA including all future business they purchase from our correspondents. As of December 31, 2004, wewere servicing $5 billion of real estate secured receivables for HSBC Bank USA. We also received fees fromHSBC Bank USA pursuant to a service level agreement under which we sourced, underwrote and priced$2.8 billion of real estate secured receivables purchased by HSBC Bank USA during 2004. These revenueshave been recorded as other income and are reÖected as real estate secured servicing revenues and real estatesecured sourcing, underwriting and pricing revenues from HSBC Bank USA in the above table.
In December 2004 we sold our domestic private label receivable portfolio, including the retained interestsassociated with our securitized domestic private label receivables to HSBC Bank USA for $12.4 billion. Werecorded an after-tax gain on the sale of $423 million. See Note 5, ""Sale of Domestic Private LabelReceivable Portfolio and Adoption of FFIEC Policies.'' We will continue to service the sold private labelreceivables and will receive servicing fee income from HSBC Bank USA for these services. Servicing feeincome from HSBC Bank USA received in December 2004 for servicing the domestic private label credit cardreceivables subsequent to the initial bulk sale totaled $2.9 million and is included in the table above as acomponent of other servicing, processing, origination and support revenues from HSBC Bank USA. Wecontinue to maintain the related customer account relationships and, therefore, will sell new domestic privatelabel receivable originations to HSBC Bank USA on a daily basis. Gains on the daily sale of new domesticprivate label receivable originations of $3 million were recorded in December 2004 subsequent to the initialbulk sale.
Under various service level agreements, we also provide various services to HSBC Bank USA. These servicesinclude credit card servicing and processing activities through our credit card services business, loanorigination and servicing through our auto Ñnance business and other operational and administrative support.Fees received for these services are reported as other income and are included in the table above as acomponent of other servicing, processing, origination and support revenues from HSBC Bank USA.
During 2003, Household Capital Trust VIII issued $275 million in mandatorily redeemable preferredsecurities to HSBC. The terms of this issuance were as follows:
(dollars are in millions)
Junior Subordinated Notes:
Principal balance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $284
Redeemable by issuer ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 26, 2008
Stated maturityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ November 15, 2033
Face valueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $275
Issue date ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ September 2003
During 2004, our Canadian business began to originate and service auto loans for an HSBC aÇliate inCanada. Fees received for these services are included in other income and are reÖected in other income fromHSBC aÇliates in the above table.
In preparation for the 2005 federal tax return preparation season, eÅective October 1, 2004 HSBC Bank USAbecame the originating lender for loans initiated by our taxpayer Ñnancial services business for clients ofvarious third party tax preparers.
On July 1, 2004, Household Bank (SB), N.A. purchased the account relationships associated with$970 million of MasterCard and Visa credit card receivables from HSBC Bank USA for approximately$99 million which are included in intangible assets. The receivables will continue to be owned by HSBC Bank
156
USA. Originations of new accounts and receivables are made by Household Bank (SB), N.A. and newreceivables are sold daily to HSBC Bank USA. Gains on the daily sale of credit card receivables to HSBCBank USA are recorded in other income.
As part of ongoing integration eÅorts, HSBC has instituted certain changes to its North Americanorganization structure. Among these initiatives was the creation of a new technology services company, HSBCTechnology and Services (USA) Inc. (""HTSU''). EÅective January 1, 2004, our technology servicesemployees, as well as technology services employees from other HSBC entities in North America, weretransferred to HTSU. In addition, technology related assets and software purchased subsequent to January 1,2004 are generally purchased and owned by HTSU. Technology related assets owned by HSBC FinanceCorporation prior to January 1, 2004 currently remain in place and were not transferred to HTSU. In additionto information technology services, HTSU also provides certain item processing and statement processingactivities to us pursuant to a master service level agreement. As a result of these changes, operating expensesrelating to services provided by HTSU, which have previously been reported as salaries and fringe beneÑts,occupancy and equipment expenses or other servicing and administrative expenses, are now reported assupport services from HSBC aÇliates. Support services from HSBC aÇliates includes services provided byHTSU as well as banking services and other miscellaneous services provided by HSBC Bank USA and othersubsidiaries of HSBC. We also receive revenue from HTSU for certain oÇce space which we have rented tothem, which has been recorded as a reduction of occupancy and equipment expenses, and for certainadministrative costs, which has been recorded as other income.
In addition, we utilize a related HSBC entity to lead manage a majority of our ongoing debt issuances. Feespaid for such services totaled approximately $18 million in 2004 and approximately $17 million for the periodMarch 29 through December 31, 2003. These fees are amortized over the life of the related debt as acomponent of interest expense.
In consideration of HSBC transferring suÇcient funds to make the payments described in Note 4 with respectto certain HSBC Finance Corporation preferred stock, we issued the Series A preferred stock in the amount of$1.1 billion to HSBC on March 28, 2003. In September 2004, HNAH issued a new series of preferred stocktotaling $1.1 billion to HSBC in exchange for our outstanding Series A preferred stock. In October 2004, wepaid the accrued dividend of $108 million on our Series A preferred stock. Also in October 2004, ourimmediate parent, HINO, issued a new series of preferred stock to HNAH in exchange for our Series Apreferred stock.
21. Stock Option Plans
Stock Option Plans The HSBC Holdings Group Share Option Plan (the ""Group Share Option Plan''), whichreplaced the former Household stock option plans, is a long-term incentive compensation plan available tocertain employees. Grants are usually made annually. Options granted to employees in 2004 vest 100% uponthe attainment of certain performance conditions in either year 3, 4 or 5 and expire 10 years from the date ofgrant. Options granted to employees in 2003 will vest 75 percent in year three with the remaining 25 percentvesting in year four and expire ten years from the date of grant. Options are granted at market value.Compensation expense related to the Group Share Option Plan, which is recognized over the vesting period,totaled $8 million in 2004 and $1 million for the period March 29 through December 31, 2003. Beginning in2005, no further options will be granted to employees although existing stock option grants will remain ineÅect subject to the same conditions as before. Instead employees will receive grants of shares of HSBC stocksubject to certain vesting conditions.
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Information with respect to the Group Share Option Plan is as follows:
2004 2003
Weighted- Weighted-HSBC Average HSBC Average
Ordinary Price per Ordinary Price perShares Share Shares Share
Outstanding at beginning of yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,069,800 $15.31 - $ -
The fair value of each option granted under the Group Share Option Plan in 2004, measured at the grant date,was calculated using a binomial lattice methodology model that is based on the underlying assumptions of theBlack-Scholes option pricing model. When modeling options with vesting are dependent on attainment ofcertain performance conditions over a period of time, these performance targets are incorporated into themodel using Monte-Carlo simulation. The expected life of options depends on the behavior of option holders,which is incorporated into the option model consistent with historic observable data. The fair values areinherently subjective and uncertain due to the assumptions made and the limitations of the model used. Priorto 2004, options were valued using a simpler methodology also based on the Black-Scholes option pricingmodel. The signiÑcant weighted average assumptions used to estimate the fair value of the options granted in2004 and 2003 are as follows:
Prior to the merger with HSBC, certain employees were eligible to participate in the former Household stockoption plan. Employee stock options generally vested equally over four years and expired 10 years from thedate of grant. Upon completion of the merger with HSBC, all options granted prior to November 2002 vestedand became outstanding options to purchase HSBC ordinary shares. Options granted under the formerHousehold plan subsequent to October 2002 were converted into options to purchase ordinary shares ofHSBC, but did not vest under the change in control. Compensation expense related to the former Householdplan totaled $8 million in 2004, $5 million in the period March 29 through December 31, 2003, $4 million inthe period January 1 through March 28, 2003 and $2 million in 2002.
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Prior to 2003, non-employee directors annually received options to purchase shares of Household's commonstock at the stock's fair market value on the day the option was granted. Director options had a term of tenyears and one day, fully vested six months from the date granted, and once vested were exercisable at any timeduring the option term. In November 2002, non-employee directors chose not to receive their annual option topurchase 10,000 shares of Household's common stock in light of the transaction with HSBC. Instead, eachdirector received a cash payment of $120,000 which was the fair market value of the options he or she wouldhave otherwise received.
Information with respect to stock options granted under the former Household plan is as follows:
2004 2003 2002
Weighted- Weighted- Weighted- Average Average AveragePrice per Price per Price per
Shares Share Shares Share Shares Share
Outstanding at beginning of year ÏÏ 45,194,343 $14.76 19,850,371 $36.80 17,750,284 $37.19
The following table summarizes information about stock options outstanding under the former Householdplan, all of which are in HSBC ordinary shares, at December 31, 2004:
Options Outstanding Options Exercisable
Weighted- Weighted- Weighted-Average Average Average
Range of Number Remaining Exercise Number ExerciseExercise Prices Outstanding Life Price Outstanding Price
The fair value of options granted under the former Household plans was estimated as of the date of grant usingthe Black-Scholes option pricing model. The fair value estimates used the following weighted-averageassumptions:
The Black-Scholes model uses diÅerent assumptions that can signiÑcantly eÅect the fair value of the options.As a result, the derived fair value estimates cannot be substantiated by comparison to independent markets.
Restricted Share Plans Subsequent to our acquisition by HSBC, key employees are also provided awards inthe form of restricted shares (""RSRs'') under HSBC's Restricted Share Plan. Awards to employees in 2004will vest over Ñve years contingent upon the achievement of certain performance targets. Additionally, in 2004,a small number of awards granted were subject only to vesting conditions of either three or Ñve years. Awardsin 2003 generally vested over a three or Ñve year period and did not require the achievement of performancetargets.
Information with respect to RSRs awarded under HSBC's Restricted Share Plan is as follows:
Prior to the merger, Household's executive compensation plans also provided for issuance of RSRs whichentitled an employee to receive a stated number of shares of Household common stock if the employeesatisÑed the conditions set by the Compensation Committee for the award. Upon completion of the mergerwith HSBC, all RSRs granted under the former Household plan prior to November 2002 vested and becameoutstanding shares of HSBC. RSRs granted under the former Household plan subsequent to October 2002were converted into rights to receive HSBC ordinary shares. Upon vesting, the employee can elect to receiveeither HSBC ordinary shares or American depository shares.
Information with respect to RSRs awarded under the pre-merger Household plan is as follows:
The pre-tax compensation cost with respect to the RSR's awarded under the pre-merger Household planreÖected above includes $5 million for the period March 29 to December 31, 2003.
Employee Stock Purchase Plans The HSBC Sharesave Contribution Plan (the ""HSBC Sharesave Plan''),which replaced the former Household employee stock purchase plan, allows eligible employees to enter into
160
savings contracts to save up to approximately $400 per month, with the option to use the savings to acquireshares. There are currently two types of plans oÅered which allow the participant to select saving contracts ofeither a 3 or 5 year length. The options are exercisable within six months following the third or Ñfth year,respectively, of the commencement of the related savings contract, at a 20 percent discount for options grantedin 2004 and 2003. HSBC ordinary shares granted and the related fair value of the options for 2004 and 2003are presented below:
2004 2003
HSBC Fair value per HSBC Fair value perordinary share of ordinary share of
3 year vesting periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,124,776 $3.44 2,810,598 $3.19
5 year vesting periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 303,981 3.80 903,171 3.28
Compensation expense related to the grants under the HSBC Sharesave Plan totaled $5 million in 2004 and$2 million for the period March 29 through December 31, 2003.
The fair value of each option granted under the HSBC Sharesave Plan was estimated as of the date of grantusing a third party option pricing model in 2004 and the Black-Scholes option pricing model in 2003. The fairvalue estimates used the following weighted-average assumptions:
Prior to the merger, we also maintained an Employee Stock Purchase Plan (the ""ESPP''). The ESPPprovided a means for employees to purchase shares of our common stock at 85 percent of the lesser of itsmarket price at the beginning or end of a one-year subscription period. The ESPP was terminated on March 7,2003 and 775,480 shares of our common stock were purchased on that date. Compensation expense related tothe ESPP totaled $7 million in the period January 1 to March 28, 2003 and $4 million in 2002.
22. Pension and Other Postretirement BeneÑts
DeÑned BeneÑt Pension Plans Our employees participate in several deÑned beneÑt pension plans coveringsubstantially all of its employees. In November 2004, sponsorship of the U.S. deÑned beneÑt pension plan ofHSBC Finance Corporation and the U.S. deÑned beneÑt pension plan of HSBC Bank USA was transferred toHNAH. EÅective January 1, 2005, the two separate plans were merged into a single deÑned pension planwhich facilitates the development of a uniÑed employee beneÑt policy and uniÑed employee beneÑt planadministration for HSBC companies operating in the United States.
Pension expense (income) for deÑned beneÑt plans included the following components:
Year ended March 29 through January 1 through Year endedDecember 31, 2004 December 31, 2003 March 28, 2003 December 31, 2002
(in millions)
Service cost Ó beneÑtsearned during the period $ 55 $ 36 $ 11 $ 33
Interest cost on projectedbeneÑt obligationÏÏÏÏÏÏÏ 53 35 5 24
Expected return on assets (91) (49) (16) (67)
Amortization of priorservice cost ÏÏÏÏÏÏÏÏÏÏÏ 1 1 - -
Recognized losses ÏÏÏÏÏÏÏÏ (5) - 14 22
Pension expense ÏÏÏÏÏÏÏÏÏ $ 13 $ 23 $ 14 $ 12
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The assumptions used in determining pension expense (income) of the domestic deÑned beneÑt plans are asfollows:
Expected long-term rate of return on plan assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8.75 8.0 8.0
(1) The discount rate used for the period January 1 through March 28, 2003 was 6.75%.
We retain an unaÇliated third party to provide investment consulting services. Given the plan's currentallocation of equity and Ñxed income securities and using investment return assumptions which are based onlong term historical data and supplied by the consultant, the long term expected return for plan assets isreasonable.
The funded status of our deÑned beneÑt pension plan was as follows:
Fair value of plan assets at end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,122 $1,072
For our domestic plan, the fair value of plan assets was $1.0 billion at December 31, 2004 and $970 million atDecember 31, 2003. We do not currently anticipate making employer contributions to our domestic deÑnedbeneÑt plan in 2005. We made contributions totaling $116 million during 2002 to improve the funded status ofour deÑned beneÑt pension plans given the declines in return on plan assets experienced during the year.
162
The actual allocation of our domestic pension plan assets at December 31, 2004 and 2003 as well as our targetallocation for 2005 are as follows:
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 2 2
- - -
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100% 100% 100%
At December 31, 2003, equity securities included our investment in 177,624 HSBC American depositoryshares with a fair value of $14 million. There were no investments in HSBC American depository shares atDecember 31, 2004.
The primary objective of our deÑned beneÑt pension plans is to provide eligible employees with regularpension beneÑts. Since our domestic plans are governed by the Employee Retirement Income Security Act of1974 (""ERISA''), ERISA regulations serve as guidance for the management of plan assets. Consistent withprudent standards of preservation of capital and maintenance of liquidity, the goals of our plans are to earn thehighest possible rate of return consistent with our tolerance for risk as determined by our investmentcommittee in its role as a Ñduciary. In carrying out these objectives, short-term Öuctuations in the value ofplan assets are considered secondary to long-term investment results. We use a third party to provideinvestment consulting services such as recommendations on the type of funds to be invested in and monitoringthe performance of fund managers. In order to achieve the return objectives of our plans, our plans arediversiÑed to ensure that adverse results from one security or security class will not have an unduly detrimentaleÅect on the entire investment portfolio. Assets are diversiÑed by type, characteristic and number ofinvestments as well as by investment style of management organization. Equity securities are invested in large,mid and small capitalization domestic stocks as well as international stocks.
A reconciliation of beginning and ending balances of the projected beneÑt obligation of the deÑned beneÑtpension plans is as follows:
Year endedDecember 31,
2004 2003
(in millions)
Projected beneÑt obligation at beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,019 $ 828
Service costÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 55 46
We also sponsor a non-qualiÑed supplemental retirement plan. This plan, which is currently unfunded,provides eligible employees deÑned pension beneÑts outside the qualiÑed retirement plan. BeneÑts are basedon average earnings, years of service and age at retirement. The projected beneÑt obligation was $82 million atDecember 31, 2004 and $80 million at December 31, 2003. Pension expense related to the supplementalretirement plan was $19 million in 2004, $9 million in the period March 29 through December 31, 2003,$3 million in the period January 1 through March 28, 2003 and $17 million in 2002. An additional minimumliability of $6 million related to this plan was recognized in 2004.
DeÑned Contribution Plans We sponsor various 401(k) savings plans and proÑt sharing plans for employeesmeeting certain eligibility requirements. Under these plans, each participant's contribution is matched by thecompany up to a maximum of 6 percent of the participant's compensation. Prior to the merger with HSBC,company contributions were in the form of Household common stock. Subsequent to the merger, companycontributions are in the form of cash. Total expense for these plans was $82 million in 2004, $50 million in theperiod March 29 through December 31, 2003, $21 million in the period January 1 through March 28, 2003and $69 million in 2002.
Postretirement Plans Other Than Pensions Our employees also participate in several plans which providemedical, dental and life insurance beneÑts to retirees and eligible dependents. These plans cover substantiallyall employees who meet certain age and vested service requirements. We have instituted dollar limits on ourpayments under the plans to control the cost of future medical beneÑts.
The net postretirement beneÑt cost included the following:
March 29 January 1Year ended through through Year ended
December 31, December 31, March 28, December 31,2004 2003 2003 2002
(in millions)
Service cost Ó beneÑtsearned during the period $ 4 $ 3 $1 $ 4
Interest cost ÏÏÏÏÏÏÏÏÏÏÏÏÏ 13 10 1 6
Expected return on assets ÏÏ - - 2 7
Amortization of priorservice cost ÏÏÏÏÏÏÏÏÏÏÏÏ - - - (2)
Recognized (gains) losses ÏÏ - - - (1)
Net periodic postretirementbeneÑt cost ÏÏÏÏÏÏÏÏÏÏÏÏ $17 $13 $4 $14
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The assumptions used in determining the net periodic postretirement beneÑt cost for our domestic postretire-ment beneÑt plans are as follows:
Accumulated beneÑt obligation at end of yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $251 $252
Our postretirement beneÑt plans are funded on a pay-as-you-go basis. We currently estimate that we will paybeneÑts of approximately $17 million relating to our postretirement beneÑt plans in 2005. The components ofthe accrued postretirement beneÑt obligation are as follows:
AtDecember 31,
2004 2003
(in millions)
Funded status ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $254 $252
Unamortized prior service costÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3) -
Unrecognized net actuarial (loss) gain ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9 3
A 11.6 percent annual rate of increase in the gross cost of covered health care beneÑts was assumed for 2005.This rate of increase is assumed to decline gradually to 5.60 percent in 2013.
Assumed health care cost trend rates have an eÅect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service andinterest costs and the postretirement beneÑt obligation as follows:
One Percent One PercentIncrease Decrease
(in millions)
EÅect on total of service and interest cost componentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $.6 $(.5)
EÅect on postretirement beneÑt obligation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8 (8)
23. Business Segments
We have three reportable segments: Consumer, Credit Card Services, and International. Our segments aremanaged separately and are characterized by diÅerent middle-market consumer lending products, originationprocesses, and locations. Our Consumer segment consists of our consumer lending, mortgage services, retailservices, and auto Ñnance businesses. Our Credit Card Services segment consists of our domestic MasterCardand Visa credit card business. Our International segment consists of our foreign operations in Canada, theUnited Kingdom and the rest of Europe. The Consumer segment provides real estate secured, automobilesecured and personal non-credit card loans. Loans are oÅered with both revolving and closed-end terms andwith Ñxed or variable interest rates. Loans are originated through branch locations, correspondents, mortgagebrokers, direct mail, telemarketing, independent merchants or automobile dealers. The Credit Card Servicessegment oÅers MasterCard and Visa credit card loans throughout the United States primarily via strategicaÇnity and co-branding relationships, direct mail, and our branch network to subprime customers. TheInternational segment oÅers secured and unsecured lines of credit and secured and unsecured closed-end loansprimarily in the United Kingdom, Canada, the Republic of Ireland, the Czech Republic and Hungary. Inaddition, the United Kingdom operation oÅers MasterCard and Visa credit cards and credit insurance inconnection with all loan products. We also cross sell our credit cards to existing real estate secured, privatelabel and tax services customers. All segments oÅer products and service customers through the Internet. TheAll Other caption includes our insurance and Taxpayer Financial Services and commercial businesses, as wellas our corporate and treasury activities, each of which falls below the quantitative threshold tests underSFAS No. 131 for determining reportable segments.
EÅective January 1, 2004, our direct lending business, which has previously been reported in our All Othercaption, was consolidated into our consumer lending business and, as a result, is now included in ourConsumer segment. Prior periods have not been restated as the impact was not material. There have been noother changes in the basis of our segmentation or any changes in the measurement of segment proÑt ascompared with the prior year presentation.
The accounting policies of the reportable segments are described in Note 2, ""Summary of SigniÑcantAccounting Policies.'' For segment reporting purposes, intersegment transactions have not been eliminated.We generally account for transactions between segments as if they were with third parties. We evaluateperformance and allocate resources based on income from operations after income taxes and returns on equityand managed assets.
We allocate resources and provide information to management for decision making on a managed basis.Therefore, an adjustment is required to reconcile the managed Ñnancial information to our reported Ñnancial
166
information in our consolidated Ñnancial statements. This adjustment reclassiÑes net interest margin, feeincome and loss provision into securitization revenue.
Income statement information included in the table for 2003 combines January 1 through March 28, 2003(the ""predecessor period'') and March 29 to December 31, 2003 (the ""successor period'') in order to present""combined'' Ñnancial results for 2003. Fair value adjustments related to purchase accounting and relatedamortization have been allocated to Corporate, which is included in the ""All Other'' caption within oursegment disclosure. As a result, managed and owned basis consolidated totals for 2003 include combinedinformation from both the ""successor'' and ""predecessor'' periods which impacts comparability to the currentperiod.
Reconciliation of our managed basis segment results to managed basis and owned basis consolidated totals areas follows:
(1) This non-GAAP Ñnancial measure is provided for comparison of our operating trends only and should be read in conjunction with our
owned basis GAAP Ñnancial information. Operating net income in 2004 excludes the gain on the bulk sale of our domestic private
label credit card receivables of $423 million (after-tax) and the impact of the adoption of FFIEC charge-oÅ policies for the domestic
private label and MasterCard/Visa credit card portfolios of $121 million (after-tax). In 2003, operating net income excludes
$167 million (after-tax) of HSBC acquisition related costs and other merger related items incurred by HSBC Finance Corporation. In
2002, operating net income excludes the $333 million (after-tax) for the settlement charge and related expenses and the loss of
$240 million (after-tax) from the disposition of Thrift assets and deposits. See ""Basis of Reporting'' for additional discussion on the
use of non-GAAP Ñnancial measures.
(2) Eliminates intersegment revenues.
(3) Eliminates bad debt recovery sales between operating segments.
(4) Tax beneÑt associated with items comprising adjustments/reconciling items.
168
(5) Eliminates investments in subsidiaries and intercompany borrowings.(6) ReclassiÑes net interest income, fee income and provision for credit losses relating to securitized receivables to other revenues.(7) Includes goodwill associated with purchase business combinations other than the HSBC merger as well as capital expenditures.(8) Represents receivables serviced with limited recourse.
24. Commitments and Contingent Liabilities
Lease Obligations: We lease certain oÇces, buildings and equipment for periods which generally do notexceed 25 years. The leases have various renewal options. The oÇce space leases generally require us to paycertain operating expenses. Net rental expense under operating leases was $117 million in 2004, $112 millionin the period March 29 through December 31, 2003, $36 million in the period January 1 through March 28,2003 and $135 million in 2002.
We have a lease obligation on a former oÇce complex which has been subleased through 2010, the end of thelease period. The sublessee has assumed our future rental obligations on this lease.
Future net minimum lease commitments under noncancelable operating lease arrangements were:
Net minimum lease commitments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $815 $227 $588
Litigation: Both we and certain of our subsidiaries are parties to various legal proceedings resulting fromordinary business activities relating to our current and/or former operations which aÅect all three of ourreportable segments. Certain of these activities are or purport to be class actions seeking damages in signiÑcantamounts. These actions include assertions concerning violations of laws and/or unfair treatment of consumers.
Due to the uncertainties in litigation and other factors, we cannot be certain that we will ultimately prevail ineach instance. Also, as the ultimate resolution of these proceedings is inÖuenced by factors that are outside ofour control, it is reasonably possible our estimated liability under these proceedings may change. However,based upon our current knowledge, our defenses to these actions have merit and any adverse decision shouldnot materially aÅect our consolidated Ñnancial condition, results of operations or cash Öows.
Other Commitments: At December 31, 2004, our mortgage services business had commitments withnumerous correspondents to purchase up to $285 million of real estate secured receivables at fair marketvalue, subject to availability based on underwriting guidelines speciÑed by our mortgage services business.These commitments have terms of up to one year and can be renewed upon mutual agreement.
25. Fair Value of Financial Instruments
In accordance with the guidelines for accounting for business combinations, the purchase price paid by HSBCplus related purchase accounting adjustments have been ""pushed-down'' and recorded in our Ñnancialstatements for the period subsequent to March 28, 2003. This has resulted in a new basis of accountingreÖecting the fair market value of our assets and liabilities for the ""successor'' period beginning March 29,2003. We have estimated the fair value of our Ñnancial instruments in accordance with SFAS No. 107,""Disclosures About Fair Value of Financial Instruments'' (""SFAS No. 107''). Fair value estimates, methodsand assumptions set forth below for our Ñnancial instruments are made solely to comply with the requirements
169
of SFAS No. 107 and should be read in conjunction with the Ñnancial statements and notes in this AnnualReport.
A signiÑcant portion of our Ñnancial instruments do not have a quoted market price. For these items, fairvalues were estimated by discounting estimated future cash Öows at estimated current market discount rates.Assumptions used to estimate future cash Öows are consistent with management's assessments regardingultimate collectibility of assets and related interest and with estimates of product lives and repricingcharacteristics used in our asset/liability management process. All assumptions are based on historicalexperience adjusted for future expectations. Assumptions used to determine fair values for Ñnancialinstruments for which no active market exists are inherently judgmental and changes in these assumptionscould signiÑcantly aÅect fair value calculations.
As required under generally accepted accounting principles, a number of other assets recorded on the balancesheets (such as acquired credit card relationships, the value of consumer lending relationships for originatedreceivables and the franchise values of our business units) are not considered Ñnancial instruments and,accordingly, are not valued for purposes of this disclosure. However, on March 29, 2003, as a result of ouracquisition by HSBC, these other assets were adjusted to their fair market value based, in part, on third partyvaluation data, under the ""push-down'' method of accounting. (See Note 4, ""Acquisitions and Divestitures.'')We believe there continues to be substantial value associated with these assets based on current marketconditions and historical experience. Accordingly, the estimated fair value of Ñnancial instruments, asdisclosed, does not fully represent our entire value, nor the changes in our entire value.
The following is a summary of the carrying value and estimated fair value of our Ñnancial instruments:
At December 31,
2004 2003
Carrying Estimated Carrying EstimatedValue Fair Value DiÅerence Value Fair Value DiÅerence
Cash: Carrying value approximates fair value due to cash's liquid nature.
Securities purchased under agreements to resell: The fair value of securities purchased under agreements toresell approximates carrying value due to their short-term maturity.
Securities: Securities are classiÑed as available-for-sale and are carried at fair value on the balance sheets.Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fairvalue is estimated using quoted market prices for similar securities.
Receivables: The fair value of adjustable rate receivables generally approximates carrying value becauseinterest rates on these receivables adjust with changing market interest rates. The fair value of Ñxed rateconsumer receivables was estimated by discounting future expected cash Öows at interest rates whichapproximate the rates that would achieve a similar return on assets with comparable risk characteristics.Receivables also includes our interest-only strip receivables. The interest-only strip receivables are carried atfair value on our balance sheets. Fair value is based on an estimate of the present value of future cash Öowsassociated with securitizations of certain real estate secured, auto Ñnance, MasterCard and Visa, private labeland personal non-credit card receivables.
Deposits: The fair value of our savings and demand accounts equaled the carrying amount as stipulated inSFAS No. 107. The fair value of Ñxed rate time certiÑcates was estimated by discounting future expected cashÖows at interest rates that we oÅer on such products at the respective valuation dates.
Commercial paper, bank and other borrowings: The fair value of these instruments approximates existingcarrying value because interest rates on these instruments adjust with changes in market interest rates due totheir short-term maturity or repricing characteristics.
Due to aÇliates: The estimated fair value of our Ñxed rate debt instruments was determined using eitherquoted market prices or by discounting future expected cash Öows at interest rates oÅered for similar types ofdebt instruments. Carrying value is typically used to estimate the fair value of Öoating rate debt.
Long term debt: The estimated fair value of our Ñxed rate debt instruments was determined using eitherquoted market prices or by discounting future expected cash Öows at interest rates oÅered for similar types ofdebt instruments. Carrying value is typically used to estimate the fair value of Öoating rate debt.
Insurance policy and claim reserves: The fair value of insurance reserves for periodic payment annuities wasestimated by discounting future expected cash Öows at estimated market interest rates at December 31, 2004and 2003. The fair value of other insurance reserves is not required to be determined in accordance withSFAS No. 107.
Derivative Ñnancial assets and liabilities: All derivative Ñnancial assets and liabilities, which exclude amountsreceivable from or payable to swap counterparties, are carried at fair value on the balance sheet. Wherepractical, quoted market prices were used to determine fair value of these instruments. For non-exchangetraded contracts, fair value was determined using accepted and established valuation methods (including inputfrom independent third parties) which consider the terms of the contracts and market expectations on thevaluation date for forward interest rates (for interest rate contracts) or forward foreign currency exchangerates (for foreign exchange contracts). We enter into foreign exchange contracts to hedge our exposure tocurrency risk on foreign denominated debt. We also enter into interest rate contracts to hedge our exposure tointerest rate risk on assets and liabilities, including debt. As a result, decreases/increases in the fair value ofderivative Ñnancial instruments which have been designated as eÅective hedges are oÅset by a correspondingincrease/decrease in the fair value of the individual asset or liability being hedged. See Note 16, ""DerivativeFinancial Instruments,'' for additional discussion of the nature of these items.
26. Attorney General Settlement
On October 11, 2002, we reached a preliminary agreement with a multi-state working group of state attorneysgeneral and regulatory agencies to eÅect a nationwide resolution of alleged violations of federal and/or stateconsumer protection, consumer Ñnancing and banking laws and regulations with respect to secured real estatelending from Household Finance Corporation and BeneÑcial Corporation and their subsidiaries conducting
171
retail branch consumer lending operations. This preliminary agreement, and related subsequent consentdecrees and similar documentation entered into with each of the 50 states and the District of Columbia, arereferred to collectively as the ""Multi-State Settlement Agreement'', which became eÅective on December 16,2002. Pursuant to the Multi-State Settlement Agreement, we funded a $484 million settlement fund that wasdivided among the states (and the District of Columbia), with each state receiving a proportionate share ofthe funds based upon the volume of the retail branch originated real estate secured loans we made in that stateduring the period of January 1, 1999 to September 30, 2002. No Ñnes, penalties or punitive damages wereassessed by the states pursuant to the Multi-State Settlement Agreement.
In August 2003, notices of a claims procedure were distributed to holders of approximately 591,000 accountsidentiÑed as having potential claims. Approximately 82% of customers accepted funds in settlement and hadexecuted a release of all civil claims against us relating to the speciÑed consumer lending practices. All checkswere mailed. Each state agreed that the settlement resolves all current civil investigations and proceedings bythe attorneys general and state lending regulators relating to the lending practices at issue.
We recorded a pre-tax charge of $525 million ($333 million after-tax) during the third quarter of 2002 relatedto the Multi-State Settlement Agreement. The charge reÖects the costs of this settlement agreement andrelated matters and has been reÖected in the statement of income in total costs and expenses.
27. Concentration of Credit Risk
A concentration of credit risk is deÑned as a signiÑcant credit exposure with an individual or group engaged insimilar activities or aÅected similarly by economic conditions.
Because we primarily lend to consumers, we do not have receivables from any industry group that equal orexceed 10 percent of total owned or managed receivables at December 31, 2004 and 2003. We lend nationwideand our receivables are distributed as follows at December 31, 2004:
Percent of Total Percent of TotalOwned Domestic Managed Domestic
State/Region Receivables Receivables
California ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12% 12%
The tables below summarize our owned basis assets, revenues and income before income taxes by materialcountry. Purchase accounting adjustments are reported within the appropriate country.
At December 31,
IdentiÑable Assets Long-Lived Assets(1)
2004 2003 2002 2004 2003 2002
(Restated)(in millions)
United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $115,938 $107,342 $89,310 $ 8,974 $ 9,132 $1,949
United Kingdom ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,468 9,401 6,845 942 809 88
Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $16,018 $14,561 $14,671 $2,940 $2,475 $2,253
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HSBC Finance Corporation
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Three Three Three Three Three Threemonths months months months months months months Mar. 29 Jan. 1ended ended ended ended ended ended ended through through
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, Mar. 28,2004 2004 2004 2004 2003 2003 2003 2003 2003
Common shareholder's(s')equity Ó as previouslyreportedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ - $16,912 $17,607 $17,049 $16,560 $15,707 $15,232 $14,723 $ 8,935
Common shareholder's(s')equity Ó as restated ÏÏÏÏÏÏÏ $15,841 $16,727 $17,379 $16,909 $16,391 $15,581 $15,606 $14,818 $ 8,935
(1) Operating net income is a non-GAAP Ñnancial measure and is provided for comparison of our operating trends only and should be read inconjunction with our owned basis GAAP Ñnancial information. For 2004, operating net income excludes the $121 million decrease in net incomerelating to the adoption of Federal Financial Institutions Examination Council charge-oÅ policies for our domestic private label and MasterCard/Visa receivables and the $423 million (after-tax) gain on the bulk sale of domestic private label receivables to an aÇliate. For 2003, operating netincome excludes HSBC acquisition related costs and other merger related items of $167 million (after-tax).
174
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
We conducted an evaluation, with the participation of the Chief Executive OÇcer and Chief Financial OÇcer,of the eÅectiveness of our disclosure controls and procedures as of the end of the period covered by this report.Our disclosure controls and procedures are designed to ensure that information required to be disclosed byHSBC Finance Corporation in the reports we Ñle or submit under the Securities Exchange Act of 1934, asamended, (the ""Exchange Act''), is recorded, processed, summarized and reported on a timely basis. Basedupon that evaluation and for the reasons described below, the Chief Executive OÇcer and Chief FinancialOÇcer concluded that our disclosure controls and procedures were not eÅective as of the end of the periodcovered by this report so as to alert them in a timely fashion to material information required to be disclosed inreports we Ñle under the Exchange Act. As a result of this conclusion, we have initiated the remedial actionsdescribed below.
HSBC Finance Corporation has restated its consolidated Ñnancial statements for the previously reportedquarterly periods ended March 31, 2004, June 30, 2004 and September 30, 2004; and the period March 29,2003 through December 31, 2003. This restatement is solely the result of the failure to satisfy certain technicalrequirements of Statement of Financial Accounting Standards No. 133, ""Accounting for Derivative Instru-ments and Hedging Activities,'' (""SFAS 133'').
During the fourth quarter of 2004, as part of our preparation for the implementation of International FinancialReporting Standards (""IFRS'') by HSBC Holdings plc (""HSBC'') from January 1, 2005, HSBC FinanceCorporation undertook a review of its hedging activities to conÑrm conformity with the requirements of IFRS,which diÅer in several respects from the hedge accounting requirements under U.S. GAAP as set out inSFAS 133. As a result of this review, we determined that there were some deÑciencies in the documentationrequired to support hedge accounting under U.S. GAAP. These documentation deÑciencies arose followingour acquisition by HSBC. As a consequence of the acquisition, pre-existing hedging relationships, includinghedging relationships that had previously qualiÑed under the ""shortcut'' method of accounting pursuant toSFAS 133, were required to be reestablished. At that time the Derivatives Implementation Group (""DIG'')had published Implementation Issue No. E-15 (""E-15'') regarding SFAS 133. Also during that time periodthere was some debate in the accounting profession regarding the detailed technical requirements resultingfrom a business combination and a proposed change by the FASB that would have changed the conclusionreached in E-15. We consulted with our independent accountants, KPMG LLP, in reaching our determinationof what was required in order to comply with SFAS 133, and E-15 in particular. Following this, HSBC Fi-nance Corporation took the actions it believed were necessary to maintain hedge accounting for all of itshistorical hedge relationships in its consolidated Ñnancial statements for the period ended December 31, 2003and those consolidated Ñnancial statements received an unqualiÑed audit opinion.
Management has concluded that the control weaknesses noted below constitute a material weakness in ourinternal controls over Ñnancial reporting relating to the process of establishing and maintaining eÅectivehedges under the shortcut method of accounting under SFAS 133. The identiÑed control weaknesses are:
‚ a failure to ensure that individuals with responsibility for implementing and administering our hedgepositions received and obtained a thorough understanding of all DIG interpretations that led to a failure tocontemporaneously fully document the accounting for hedging relationships under SFAS 133; and
‚ a failure to establish and maintain eÅective systems and communication between the Treasury andAccounting functions so as to achieve hedge accounting eÅectively and transparently.
175
In response to these identiÑed weaknesses, we are taking the following remedial actions:
‚ until the hedge operation is adequately staÅed with employees with suÇcient expertise in hedge accountingrequirements under SFAS 133, retain external service providers with an expertise in hedge accountingrequirements to provide the support necessary to fully comply with hedge accounting requirements; and
‚ establish detailed polices and procedures that will ensure that personnel remain current on all relevantstandards for hedge accounting requirements, including those relating to the shortcut method underSFAS 133.
These remedial actions will be undertaken immediately.
HSBC Finance Corporation continues the process to complete a thorough review of its internal controls aspart of its preparation for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of2002. Section 404 requires our management to report on, and our external auditors to attest to, theeÅectiveness of our internal control structure and procedures for Ñnancial reporting. As a non-accelerated Ñlerunder Rule 12b-2 of the Exchange Act, our Ñrst report under Section 404 will be contained in our Form 10-Kfor the period ended December 31, 2005.
Item 9B. Other Information.
None.
PART III
Item 10. Directors and Executive OÇcers of the Registrant.
In accordance with the requirements of Form 10-K, we are Ñling this report using the reduced disclosureformat and therefore are not required to provide information pursuant to this Item 10. However, we areproviding the following information to provide disclosure concerning our corporate governance practices andspeciÑcally with respect to the audit committee of our Board of Directors.
The primary purpose of the audit committee is to assist the Board of Directors in fulÑlling its oversightresponsibilities relating to HSBC Finance Corporation's accounting, auditing and Ñnancial reporting practices.The audit committee is currently comprised of the following independent Directors (as deÑned by thestandards of the New York Stock Exchange): Gary G. Dillon; Robert K. Herdman and Larree M. Renda. Inaddition, John D. Nichols, Lead Director, and Alan W. Jebson, Chief Operating OÇcer of HSBC, are ex-oÇcio members of the Committee. The Board has determined that each of these individuals is Ñnanciallyliterate. The Board of Directors has determined that Robert K. Herdman qualiÑes as an audit committeeÑnancial expert.
Code of Ethics
HSBC Finance Corporation's Board of Directors has adopted a Code of Ethics for Senior Financial OÇcers.That Code of Ethics is included as Exhibit 14 to this Annual Report on Form 10-K. HSBC FinanceCorporation also has a general code of ethics applicable to all employees that is referred to as its Statement ofBusiness Principles and Code of Ethics. That document is available on our website at www.household.com orupon written request made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois60070, Attention: Corporate Secretary.
176
Item 11. Executive Compensation.
Omitted.
Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Matters.
Omitted.
Item 13. Certain Relationships and Related Transactions.
Omitted.
Item 14. Principal Accountant Fees and Services.
Audit Fees. The aggregate amount billed by our principal accountant, KPMG LLP, for audit servicesperformed during the Ñscal years ended December 31, 2004 and 2003 was $5,565,000 and $5,687,000,respectively. Audit services include the auditing of Ñnancial statements, quarterly reviews, statutory audits andthe preparation of comfort letters, consents and review of registration statements.
Audit Related Fees. The aggregate amount billed by KPMG LLP in connection with audit related servicesperformed during the Ñscal years ended December 31, 2004 and 2003 was $691,000 and $1,250,000,respectively. Audit related services include employee beneÑt plan audits, due diligence assistance, internalcontrol review assistance and audit or attestation services not required by statute or regulation.
Tax Fees. Total fees billed by KPMG LLP for tax related services for the Ñscal years ended December 31,2004 and 2003 were $2,656,000 and $779,000, respectively. These services include tax related research,general tax services in connection with transactions and legislation and tax services for review of federal andstate tax accounts for possible overassessment of interest and/or penalties.
All Other. Other than those fees described above, there were no other fees billed for services performed byKPMG LLP during the Ñscal years ended December 31, 2004 and December 31, 2003.
All of the fees described above were approved by HSBC Finance Corporation's audit committee.
Audit Committee Pre-Approval Policies and Procedures. HSBC Finance Corporation's audit committee pre-approves the audit and non-audit services performed by KPMG LLP, our principal accountants, in order toassure that the provision of such services does not impair KPMG LLP's independence. Unless a type ofservice to be provided by KPMG LLP has received general pre-approval, it will require speciÑc pre-approvalby the audit committee. In addition, any proposed services exceeding pre-approval cost levels will requirespeciÑc pre-approval by the audit committee.
The term of any pre-approval is 12 months from the date of pre-approval, unless the audit committeespeciÑcally provides for a diÅerent period. The audit committee will periodically revise the list of pre-approvedservices, based on subsequent determinations, and has delegated pre-approval authority to the Chairman ofthe audit committee. In the event the Chairman exercises such delegated authority, he will report such pre-approval decisions to the audit committee at its next scheduled meeting. The audit committee does notdelegate its responsibilities to pre-approve services performed by the independent auditor to management.
177
PART IV
Item 15. Exhibits and Financial Statement Schedule.
(a)(1) Financial Statements.
The consolidated Ñnancial statements listed below, together with an opinion of KPMG LLP datedFebruary 28, 2005 with respect thereto, are included in this Form 10-K pursuant to Item 8. FinancialStatements and Supplementary Data of this Form 10-K.
HSBC Finance Corporation and Subsidiaries:
Report of Independent Registered Public Accounting FirmConsolidated Statements of IncomeConsolidated Balance SheetsConsolidated Statements of Cash FlowsConsolidated Statements of Changes in Preferred Stock and CommonShareholder's(s') EquityNotes to Consolidated Financial StatementsSelected Quarterly Financial Data (Unaudited)
(a)(2) Not applicable
(a)(3) Exhibits.
3(i) Amended and Restated CertiÑcate of Incorporation of HSBC Finance Corporation datedas of December 15, 2004.
3(ii) Restated Bylaws of HSBC Finance Corporation dated as of December 15, 2004.
4.1 Amended and Restated Standard Multiple-Series Indenture Provisions for Senior DebtSecurities of HSBC Finance Corporation dated as of December 15, 2004 (incorporatedby reference to Exhibit 4.1 to the Registration Statement on Form S-3 of HSBC FinanceCorporation, Nos. 333-120494, 333-120495 and 333-120496 Ñled on December 16,2004).
4.2* Amended and Restated Indenture dated as of December 15, 2004 for Senior DebtSecurities between HSBC Finance Corporation and JPMorgan Chase Bank, N.A. (assuccessor to The Chase Manhattan Bank (National Association)), as Trustee (incorpo-rated by reference to Exhibit 4.2 to the Registration Statement on Form S-3 of HSBCFinance Corporation, Nos. 333-120495 and 333-120496 Ñled on December 16, 2004).
4.3 The principal amount of debt outstanding under each other instrument deÑning the rightsof Holders of our long-term senior and senior subordinated debt does not exceed10 percent of our total assets. HSBC Finance Corporation agrees to furnish to theSecurities and Exchange Commission, upon request, a copy of each instrument deÑningthe rights of holders of our long-term senior and senior subordinated debt.
12 Statement of Computation of Ratio of Earnings to Fixed Charges and to CombinedFixed Charges and Preferred Stock Dividends.
14 Code of Ethics for Senior Financial OÇcers.
23 Consent of KPMG LLP, Independent Registered Public Accounting Firm.
24 Power of Attorney (included on page 180 of this Form 10-K).
31 CertiÑcation of Chief Executive OÇcer and Chief Financial OÇcer pursuant to Section302 of the Sarbanes-Oxley Act of 2002.
32 CertiÑcation of Chief Executive OÇcer and Chief Financial OÇcer pursuant to Section906 of the Sarbanes-Oxley Act of 2002.
99.1 Ratings of HSBC Finance Corporation and its signiÑcant subsidiaries.
178
Upon receiving a written request, we will furnish copies of the exhibits referred to above free of charge.Requests should be made to HSBC Finance Corporation, 2700 Sanders Road, Prospect Heights, Illinois60070, Attention: Corporate Secretary.
* Substantially identical indentures exist with U.S. Bank National Association, BNY Midwest Trust Company and JPMorgan Trust
Company, National Association.
179
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, HSBC FinanceCorporation has duly caused this report to be signed on its behalf by the undersigned, thereunto dulyauthorized on this, the 23rd day of February, 2005.
HSBC FINANCE CORPORATION
By: /s/ W.F. Aldinger
W.F. AldingerChairman and Chief Executive OÇcer
Each person whose signature appears below constitutes and appoints P.D. Schwartz as his/her true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitution, for him/her in his/her name,place and stead, in any and all capacities, to sign and Ñle, with the Securities and Exchange Commission, thisForm 10-K and any and all amendments and exhibits thereto, and all documents in connection therewith,granting unto each such attorney-in-fact and agent full power and authority to do and perform each and everyact and thing requisite and necessary to be done, as fully to all intents and purposes as he/she might or coulddo in person, hereby ratifying and conÑrming all that such attorney-in-fact and agent or their substitutes maylawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of HSBC Finance Corporation and in the capacities indicated on the 23rd day ofFebruary, 2005.
Signature Title
/s/ W. F. ALDINGER Chairman and Chief Executive OÇcer and Director(as Principal Executive OÇcer)(W. F. Aldinger)
/s/ W. R. P. DALTON Director
(W. R. P. Dalton)
/s/ R. J. DARNALL Director
(R. J. Darnall)
/s/ G. G. DILLON Director
(G. G. Dillon)
/s/ A. DISNEY Director
(A. Disney)
/s/ J. A. EDWARDSON Director
(J. A. Edwardson)
Director(J. D. Fishburn)
/s/ C. F. FREIDHEIM, JR. Director
(C. F. Freidheim, Jr.)
/s/ R. K. HERDMAN Director
(R. K. Herdman)
180
Signature Title
/s/ A. W. JEBSON Director
(A. W. Jebson)
/s/ G. A. LORCH Director
(G. A. Lorch)
/s/ J. D. NICHOLS Director
(J. D. Nichols)
/s/ L. M. RENDA Director
(L. M. Renda)
/s/ S. J. STEWART Director
(S. J. Stewart)
/s/ B. A. SIBBLIES Senior Vice President and Chief Accounting OÇcer(as Principal Accounting OÇcer)(B. A. Sibblies)
/s/ S. C. PENNEY Senior Executive Vice President and Chief FinancialOÇcer (as Principal Financial OÇcer)(S. C. Penney)
181
Exhibit Index
3(i) Amended and Restated CertiÑcate of Incorporation of HSBC Finance Corporation dated as ofDecember 15, 2004.
3(ii) Restated Bylaws of HSBC Finance Corporation dated as of December 15, 2004.
4.1 Amended and Restated Standard Multiple-Series Indenture Provisions for Senior Debt Securities ofHSBC Finance Corporation dated as of December 15, 2004 (incorporated by reference to Exhibit 4.1to the Registration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120494,333-120495 and 333-120496 Ñled on December 16, 2004).
4.2* Amended and Restated Indenture dated as of December 15, 2004 for Senior Debt Securities betweenHSBC Finance Corporation and JPMorgan Chase Bank, N.A. (as successor to The Chase Manhat-tan Bank (National Association)), as Trustee (incorporated by reference to Exhibit 4.2 to theRegistration Statement on Form S-3 of HSBC Finance Corporation, Nos. 333-120495 and333-120496 Ñled on December 16, 2004).
4.3 The principal amount of debt outstanding under each other instrument deÑning the rights of Holdersof our long-term senior and senior subordinated debt does not exceed 10 percent of our total assets.HSBC Finance Corporation agrees to furnish to the Securities and Exchange Commission, uponrequest, a copy of each instrument deÑning the rights of holders of our long-term senior and seniorsubordinated debt.
12 Statement of Computation of Ratio of Earnings to Fixed Charges and to Combined Fixed Chargesand Preferred Stock Dividends.
14 Code of Ethics for Senior Financial OÇcers.
23 Consent of KPMG LLP, Independent Registered Public Accounting Firm.
24 Power of Attorney (included on page 180 of this Form 10-K).
31 CertiÑcation of Chief Executive OÇcer and Chief Financial OÇcer pursuant to Section 302 of theSarbanes-Oxley Act of 2002.
32 CertiÑcation of Chief Executive OÇcer and Chief Financial OÇcer pursuant to Section 906 of theSarbanes-Oxley Act of 2002.
99.1 Ratings of HSBC Finance Corporation and its signiÑcant subsidiaries.
* Substantially identical indentures exist with U.S. Bank National Association, BNY Midwest Trust Company and JPMorgan Trust
Company, National Association.
EXHIBIT 3(i)
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
of
HSBC FINANCE CORPORATION
December 15, 2004
ARTICLE I
The name of the corporation is HSBC Finance Corporation (hereinafter referred to as the ""Corporation'').
ARTICLE II
The registered oÇce of the Corporation is to be located at 1209 Orange Street, in the City of Wilmington, inthe County of New Castle, in the State of Delaware. The name of its registered agent at that address is TheCorporation Trust Company.
ARTICLE III
The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may beorganized under the General Corporation Law of Delaware.
ARTICLE IV
(1) The total number of shares of all classes of stock which the Corporation shall have the authority to issueis 1200 shares, of which 100 shares, par value $0.01, shall be of a class designated ""common stock'', and1100 shares, par value $0.01 per share, shall be of a class designated ""preferred stock''.
(2) The common stock of the Corporation shall be subject to the express terms of the preferred stock and anyseries thereof. Each share of common stock shall have the right to cast on vote for each share for the electionof directors and on all other matters upon which stockholders are entitled to vote.
(3) The Board of Directors is authorized, subject to limitations prescribed by law and the provisions of thisArticle IV, to provide for the issuance from time to time in one or more series of any number of shares ofpreferred stock, and, by Ñling a certiÑcate pursuant to the Delaware General Corporation Law (the ""PreferredStock Designation''), to establish the number of shares to be included in each series, and to Ñx thedesignations, relative rights, preferences, qualiÑcations and limitations of the shares of each such series. Theauthority of the Board of Directors with respect to each series shall include, but not be limited to,determination of the following:
(i) the designation of the series, which may be by distinguishing number, letter or title;
(ii) the number of shares of the series, which number the Board of Directors may thereafter (exceptwhere otherwise provided in the Preferred Stock Designation) increase or decrease (but not below the numberof shares thereof them outstanding);
(iii) the voting rights, if any, of the holders of shares of the series;
(iv) shall be cumulative or noncumulative and the dividend rate of the series, and the preferences, if any,over any other series (or of any other series over such series) with respect to dividends;
(v) dates at which dividends, if any, shall be payable;
(vi) the redemption rights and price or prices, if any, for shares of the series;
(vii) the amounts payable on, and the preferences, if any, of shares of the series in the event of anyvoluntary or involuntary liquidation, dissolution, distribution of assets or winding up of the aÅairs of theCorporation;
(viii) the terms and amount of any purchase, retirement or sinking fund provided for the purchase orredemption of shares of the series;
(ix) whether the shares of the series shall be convertible into or exchangeable for shares of any otherclass or series, or any other security, of the Corporation or any other corporation, and, if so, the speciÑcation ofsuch other class or series of such other security, the conversion or exchange price or prices or rate or rates, anyadjustments thereof, the date or dates at which such shares shall be convertible or exchangeable and all otherterms and conditions upon which such conversion or exchange may be made;
(x) whether the issuance of additional shares of preferred stock shall be subject to restrictions as toissuance, or as to the powers, preferences or other rights of any other series;
(xi) the right of the shares of such series to the beneÑt of conditions and restrictions upon the creation ofindebtedness of the Corporation or any subsidiary of the Corporation, upon the issue of any additional stock(including additional shares of such series or any other series) and upon the payment of dividends or themaking of other distributions on, and the purchase, redemption or other acquisition by the Corporation or anysubsidiary of any outstanding stock of the Corporation; and
(xii) such other powers, preferences and relative, participating, optional and other special rights, and thequaliÑcations, limitations and restrictions thereof as the Board of Directors shall determine.
The holders of preferred stock shall not have any preemptive rights except to the extent such rights shall bespeciÑcally provided for in the resolution or resolutions providing for the issuance thereof adopted by theBoard of Directors.
ARTICLE V
The name and address of the incorporator is as follows:
Brandon W. GardnerCleary, Gottlieb, Steen & HamiltonOne Liberty PlazaNew York, New York 10006
ARTICLE VI
Names of the persons constituting the initial Board of Directors of the Corporation are as follows:
Youseef A. Nasr452 Fifth Ave., 10th FloorNew York, NY 10018
Paul L. Lee452 Fifth Ave., 7th FloorNew York, NY 10018
ARTICLE VII
The following provisions are inserted for the management of the business and for the conduct of the aÅairs ofthe Corporation, and for further deÑnition, limitation and regulation of the powers of the Corporation and ofits directors and stockholders:
(1) The number of directors of the Corporation shall be such as from time to time shall be Ñxed by, or inthe manner provided in, the by-laws. Election of directors need not be by ballot unless the by-laws so provide.
2
(2) The Board of Directors shall have powers without the assent or vote of the stockholders to make,alter, amend, change, add to or repeal the by-laws of the Corporation; to Ñx and vary the amount to be servedfor any proper purpose; to authorize and cause to be executed mortgages and liens upon all or any part of theproperty of the Corporation; to determine the use and disposition of any surplus or net proÑts; and to Ñx thetimes for the declaration and payment of dividends.
(3) The directors in their discretion may submit any contract or act for approval or ratiÑcation at anyannual meeting of the stockholders or at any meeting of the stockholders called for the purpose of consideringany such act or contract, and any contract or act that shall be approved or be ratiÑed by the vote of the holdersof a majority of the stock of the Corporation which is represented in person or by proxy at such meeting andentitled to vote thereat (provided that a lawful quorum of stockholders be there represented in person or byproxy) shall be as valid and as binding upon the Corporation and upon all the stockholders as though it hadbeen approved or ratiÑed by every stockholder of the Corporation, whether or not the contract or act wouldotherwise be open to legal attack because of directors' interest, or of any other reason.
(4) In addition to the powers and authorities hereinbefore or by statute expressly conferred upon them,the directors are hereby empowered to exercise all such powers and do all such acts and things as may beexercised or done by the Corporation; subject, nevertheless, to the provisions of the statutes of Delaware, ofthis certiÑcate, and to any by-laws from time to time made by the stockholders; provided, however, that noby-laws so made shall invalidate any prior act of the directors which would have been valid if such by-law hadnot been made.
ARTICLE VIII
(1) Each person who was or is made a party or is threatened to be made a party to or is involved in any action,suit or proceeding, whether civil, criminal, administrative, or investigative (hereinafter a ""proceeding''), byreason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director,oÇcer, or employee of the Corporation or is or was serving at the request of the Corporation as a director,oÇcer, employee, or agent of another corporation or of a partnership, joint venture, trust, or other enterprise,including service with respect to employee beneÑt plans, shall be indemniÑed and held harmless by theCorporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists ormay hereafter be amended (but, in the case of any such amendment, only to the extent that such amendmentpermits the Corporation to provide broader indemniÑcation rights than said law permitted the Corporation toprovide prior to such amendment), against all expense, liability, and loss (including attorneys' fees, judgments,Ñnes, ERISA excise taxes, or penalties and amounts paid or to be paid in settlement) reasonably incurred orsuÅered by such person in connection therewith, and such indemniÑcation shall continue as to a person whohas ceased to be a director, oÇcer, employee, or agent and shall inure to the beneÑt of his or her heirs,executors and administrators; provided, however, that except as provided in paragraph (2) hereof, theCorporation shall indemnify any such person seeking indemniÑcation in connection with a proceeding (or partthereof) initiated by such person only if such proceeding (or part thereof) was authorized by the Board ofDirectors of the Corporation. The right to indemniÑcation conferred in this Section shall be a contract rightand shall include the right to be paid by the Corporation the expenses incurred in defending any suchproceeding in advance of its Ñnal disposition upon delivery to the Corporation of any undertaking to repay allamounts so advanced if it shall ultimately be determined that such person is not entitled to be indemniÑedunder this Section or otherwise. The Corporation may, by action of its Board of Directors, provideindemniÑcation to agents of the Corporation with the same scope and eÅect as the foregoing indemniÑcationof directors, oÇcers, and employees.
(2) If a claim under paragraph (1) of this Section is not paid in full by the Corporation, the claimant may atany time thereafter bring suit against the Corporation to recover the unpaid amount of the claim and, ifsuccessful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting suchclaim. It shall be a defense to any such action (other than an action brought to enforce a claim for expensesincurred in defending any proceeding in advance of its Ñnal disposition where the required undertaking hasbeen tendered to the Corporation) that the claimant has not met the standards of conduct which make it
3
permissible under the Delaware General Corporation Law and paragraph (1) of this Section for theCorporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shallbe on the Corporation. Neither the failure of the Corporation (including its Board of Directors, independentlegal counsel, or its stockholders) to have made a determination prior to the commencement of such actionthat indemniÑcation of the claimant is proper in the circumstances because he or she has met the applicablestandard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by theCorporation (including its Board of Directors, independent legal counsel, or its stockholders) that theclaimant has not met such applicable standard of conduct, shall be a defense to the action or create apresumption that the claimant has not met the applicable standard of conduct.
(3) The right to indemniÑcation and the payment of expenses incurred in defending a proceeding in advanceof its Ñnal disposition conferred in this Section shall not be exclusive of any other right which any person mayhave or hereafter acquire under any statute, provision of this CertiÑcate of Incorporation, bylaw, agreement,contract, vote of stockholders or disinterested directors, or otherwise.
(4) The Corporation may purchase and maintain insurance on behalf of any person who is or was a director,serving at the request of the Corporation as a director, oÇcer, employee or agent of another corporation,partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred byhim in any such capacity, or arising out of his status as such, whether or not the Corporation would have thepower to indemnify him against such liability under the provisions of this Section, the Delaware GeneralCorporation Law, or otherwise.
ARTICLE IX
Whenever a compromise or arrangement is proposed between the Corporation and its creditors or any class ofthem and/or between the Corporation and its stockholders or any class of them, any court of equitablejurisdiction within the State of Delaware, may, on the application in a summary way of the Corporation or ofany creditor or stockholder thereof or on the application of any receiver or receivers appointed for theCorporation under the provisions of section 291 of Title 8 of the Delaware Code or on the application oftrustees in dissolution or of any receiver or receivers appointed for the Corporation under the provisions ofsection 271 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of thestockholders or class of stockholders of the Corporation, as the case may be, to be summoned in such manneras the said court directs. If a majority in number representing three-fourths in value of the creditors or class ofcreditors, and/or of the stockholders or class of stockholders of the Corporation, as the case may be, agree toany compromise or arrangement and to any reorganization of the Corporation as consequence of suchcompromise or arrangement, the said compromise or arrangement and the said reorganization shall, ifsanctioned by the court to which the said application has been made, be binding on all the creditors or class ofcreditors, and/or on all the stockholders or class of stockholders, of the Corporation, as the case may be, andalso on the Corporation.
ARTICLE X
The Corporation reserves the right to amend, alter, change or repeal any provisions contained in this certiÑcateof incorporation in the manner now or hereafter prescribed by law, and all rights and powers conferred hereinon stockholders, directors and oÇcers are subject to this reserved power.
ARTICLE XI
The personal liability of the directors of the Corporation is hereby eliminated to the fullest extent permitted byparagraph (7) of subsection (b) of Section 102 of the General Corporation Law of the State of Delaware, asthe same may be amended or supplemented.
4
EXHIBIT 3(ii)
HSBC FINANCE CORPORATION
BYLAWS
(As in eÅect December 15, 2004)
BYLAWS OF
HSBC FINANCE CORPORATION
ARTICLE I.
DEFINITIONS, PLACES OF MEETINGS.
SECTION 1. DeÑnitions. When used herein, ""Board'' shall mean the Board of Directors of this Corporation,and ""Chairman'' shall mean Chairman of the Board of Directors.
SECTION 2. Places of Meetings of Stockholders and Directors. Unless the Board shall Ñx another place forthe holding of the meeting, meetings of stockholders and of the Board shall be held at the Corporation'sheadquarters, Prospect Heights, Cook County, Illinois, or at such other place speciÑed by the person orpersons calling the meeting.
ARTICLE II.
STOCKHOLDERS MEETINGS.
SECTION 1. Annual Meeting of Stockholders. The annual meeting of stockholders shall be held on suchdate and at such time as is Ñxed by the Board. Any previously scheduled annual meeting of stockholders maybe postponed by resolution of the Board of Directors upon public announcement given prior to the datepreviously scheduled for such annual meeting of stockholders.
SECTION 2. Special Meetings.
Call. Special meetings of the stockholders may be called at any time by the Chief Executive OÇcer or amajority of the Board of Directors. Any previously scheduled special meeting of stockholders may bepostponed by resolution of the Board of Directors upon notice to the stockholders given prior to the datepreviously scheduled for such special meeting of stockholders.
Requisites of Call. A call for a special meeting of stockholders shall be in writing, Ñled with the Secretary,and shall specify the time and place of holding such meeting and the purpose or purposes for which it is called.
SECTION 3. Notice of Meetings. Written notice of a meeting of stockholders setting forth the place, date,and hour of the meeting and the purpose or purposes for which the meeting is called shall be mailed not lessthan ten nor more than sixty days before the date of the meeting to each stockholder entitled to vote at themeeting.
SECTION 4. Quorum and Adjournments. At any meeting of stockholders, the holders of a majority of allthe outstanding shares entitled to vote, present in person or by proxy, shall constitute a quorum for thetransaction of business, and a majority of such quorum shall prevail except as otherwise required by law, theCertiÑcate of Incorporation, or the bylaws.
If the stockholders necessary for a quorum shall fail to be present at the time and place Ñxed for any meeting,the holders of a majority of the shares entitled to vote who are present in person or by proxy may adjourn themeeting from time to time, until a quorum is present, provided, however, that any stockholders' meeting,annual or special, whether or not a quorum is present, may be adjourned from time to time by the Chairman ofthe meeting. At any adjourned meeting, any business may be transacted which might have been transacted atthe original meeting.
SECTION 5. Polls. The date and time of the opening and the closing of the polls for each matter uponwhich the stockholders will vote at a meeting shall be announced at the meeting. No ballot, proxies or votes,nor any revocations thereof or changes thereto, shall be accepted by the inspectors after the closing of the pollsunless the Court of Chancery of the State of Delaware upon application by a stockholder shall determineotherwise.
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ARTICLE III.
BOARD OF DIRECTORS.
SECTION 1. General Powers. The business and aÅairs of this Corporation shall be managed under thedirection of the Board.
Number. The number of directors shall be Ñxed from time to time by resolution of the Board.
Tenure. The directors shall be elected at the annual meeting of stockholders, except as provided in Section 5of this Article III, and each director shall hold oÇce until his successor is elected and qualiÑed or until hisearlier resignation or removal.
SECTION 2. Regular Meetings of the Board. Regular meetings of the Board shall be held at such times andplaces as the Board may Ñx. No notice shall be required.
SECTION 3. Special Meetings of the Board. Special meetings of the Board shall be held whenever called bythe Chairman of the Board or Chief Executive OÇcer or any four or more directors. At least twenty-fourhours written notice or oral notice of each special meeting shall be given to each director. If mailed, noticemust be deposited in the United States mail at least seventy-two hours before the meeting.
SECTION 4. Quorum. A majority of the members of the Board if the total number is odd or one-halfthereof if the total number is even shall constitute a quorum for the transaction of business, but if at anymeeting of the Board there is less than a quorum the majority of those present may adjourn the meeting fromtime to time until a quorum is present. At any such adjourned meeting, a quorum being present, any businessmay be transacted which might have been transacted at the original meeting.
Except as otherwise provided by law, the CertiÑcate of Incorporation, or the bylaws, all actions of the Boardshall be decided by vote of a majority of those present.
SECTION 5. Vacancies. When any vacancy occurs among the Board, the remaining members of the Boardmay elect a director to Ñll each such vacancy at any regular meeting of the Board, or at a special meetingcalled for that purpose. A director elected to Ñll a vacancy shall serve for the unexpired portion of the term ofhis predecessor in oÇce.
SECTION 6. Removal of Directors. Any director may be removed either with or without cause, at any time,by a vote of the holders of a majority of the shares of the Corporation at any meeting of stockholders called forthat purpose.
SECTION 7. Committees. The Board may, by resolution passed by a majority of the entire Board, designateone or more committees of directors which to the extent provided in the resolution shall have and may exercisepowers and authority of the Board in the management of the business and aÅairs of the Corporation.
SECTION 8. Action of the Board. Except as otherwise provided by law, corporate action to be taken by theBoard shall mean such action at a meeting of the Board. Any action required or permitted to be taken by theBoard may be taken without a meeting if all members of the Board consent in writing to a resolutionauthorizing the action. The resolution and the written consents thereto shall be Ñled with the minutes of theproceedings of the Board. Any one or more members of the Board may participate in a meeting of the Boardby means of a conference telephone or similar communications equipment allowing all persons participating inthe meeting to hear each other at the same time. Participation by such means shall constitute presence inperson at a meeting.
ARTICLE IV.
OFFICERS.
SECTION 1. OÇcers. The Policy Making OÇcers of the Corporation shall be appointed by the Board ofDirectors at the next meeting of the Board following the Annual Meeting of Stockholders. The Board ofDirectors shall also appoint General OÇcers to manage the day-to-day business functions of the Corporation.
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Policy Making OÇcers shall have the authority to appoint other Assistant OÇcers to assist in the ministerialaspects of their area of responsibilities.
The Policy Making OÇcers of the Corporation shall be the Chairman of the Board, the Chief ExecutiveOÇcer, the Chief Operating OÇcer (if any), the Chief Financial OÇcer (if any), the President (if any), anyVice Chairman (if any), any Senior Executive Vice President, any Executive Vice President, any Senior VicePresident or Group Executive, the General Counsel (if any) and the Chief Accounting OÇcer (if any). TheGeneral OÇcers of the Corporation shall be any Vice President, any Managing Director, the Controller (ifany), the Treasurer and the Secretary. Any person holding the title of Chairman or Chief Executive OÇcershall be a director of the Corporation.
The Board may from time to time designate, employ, or appoint such other oÇcers and assistant oÇcers,agents, employees, counsel, and attorneys at law or in fact as it shall deem desirable for such periods and onsuch terms as it may deem advisable, and such persons shall have such titles, only such power and authority,and perform such duties as the Board may determine.
SECTION 2. Duties of Chairman of the Board. The Chairman shall sign and issue, jointly with thePresident (if any), all reports to the stockholders and shall preside at all meetings of stockholders and of theBoard. He shall, in general, perform duties incident to the oÇce of Chairman as may be prescribed by theBoard.
SECTION 3. Duties of Chief Executive OÇcer. At the next meeting of the Board following the AnnualMeeting of Stockholders, or other meeting at which Policy Making OÇcers are or may be elected, the Boardshall designate the Chairman or the President (if any) as the Chief Executive OÇcer of the Corporation. TheChief Executive OÇcer shall have general authority over all matters relating to the business and aÅairs of theCorporation subject to the control and direction of the Board. In the absence or inability of the ChiefExecutive OÇcer to act, the Chair of the Executive Committee of the Board shall perform the duties of theChief Executive OÇcer.
SECTION 4. Duties of President. The President, if one is appointed by the Board, shall, in general, performall duties incident to the oÇce of President and shall perform such other duties as may be prescribed by theBoard. In the absence or inability of the Chairman, or the Chair of the Executive Committee in accordancewith Section 3 above, to act, the President shall perform the duties of the Chairman and Chief ExecutiveOÇcer for such time period as required.
SECTION 5. Duties of a Vice Chairman. A Vice Chairman, if one is appointed by the Board, shall, ingeneral, perform all duties incident to the oÇce of a Vice Chairman and shall perform such other duties asmay be prescribed by the Board. In the absence or inability of the President or the Chair of the ExecutiveCommittee to act as the Chief Executive OÇcer in accordance with Sections 3 and 4 above, the most seniorVice Chairman, as designated by the Chairman, shall perform the duties of the Chief Executive OÇcer andChairman for such time period as required.
SECTION 6. Duties of Senior Executive Vice Presidents, Executive Vice Presidents, Group Executives andSenior Vice Presidents. Each Senior Executive Vice President, Executive Vice President, Group Executiveand Senior Vice President shall have such powers and perform such duties as may be prescribed by the ChiefExecutive OÇcer of the Corporation or the Board. The order of seniority, if any, among the Senior ExecutiveVice Presidents, Executive Vice Presidents, Group Executives and Senior Vice Presidents shall be asdesignated from time to time by the Chief Executive OÇcer of the Corporation. In the absence or inability ofany Vice Chairman to act as the Chief Executive OÇcer as may be required in accordance with Section 5above, the senior of the Senior Executive Vice Presidents, Executive Vice Presidents, Group Executives andSenior Vice Presidents, if one has been so designated, shall perform the duties of the Chief Executive OÇcerand Chairman for such time period as required.
SECTION 7. Duties of Secretary. The Secretary shall record the proceedings of meetings of the stockholdersand directors, give notices of meetings, and shall, in general, perform all duties incident to the oÇce ofSecretary and such other duties as may be prescribed by the Board.
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SECTION 8. Duties of Treasurer. The Treasurer shall have custody of all funds, securities, evidences ofindebtedness, and other similar property of the Corporation, and shall, in general, perform all duties incidentto the oÇce of Treasurer and such other duties as may be prescribed by the Board.
ARTICLE V.
STOCK AND STOCK CERTIFICATES.
SECTION 1. Transfers. Shares of stock shall be transferable on the books of the Corporation only by theperson named in the certiÑcate or by an attorney, lawfully constituted in writing, and upon surrender of thecertiÑcate therefor. Every person becoming a stockholder by such transfer shall, in proportion to his shares,succeed to all rights of the prior holder of such shares.
SECTION 2. Stock CertiÑcates. The certiÑcates of stock of the Corporation shall be numbered and shall beentered in the books of the Corporation as they are issued. They shall exhibit the holder's name and number ofshares and shall be signed by the President or Vice President and the Secretary or Treasurer. Every certiÑcateshall have noted thereon any information required to be set forth by the applicable law. If the Corporation hasa transfer agent or an assistant transfer agent or a transfer clerk acting on its behalf and a registrar, thesignature of any such oÇcer may be a facsimile. In case any oÇcer or oÇcers who shall have signed, or whosefacsimile signature or signatures shall have been used on any such certiÑcate or certiÑcates shall cease to besuch oÇcer or oÇcers of the Corporation, whether because of death, resignation or otherwise, before suchcertiÑcate or certiÑcates shall have been delivered by the Corporation, such certiÑcate or certiÑcates maynevertheless be adopted by the Corporation and be issued and delivered as though the person or persons whosigned such certiÑcate or certiÑcates or whose facsimile signatures shall have been used thereon had notceased to be such oÇcer or oÇcers of the Corporation.
SECTION 3. Fixing Record Date.
(A) In order that the Corporation may determine the stockholders entitled to notice of or to vote at anymeeting of stockholders or any adjournment thereof, or to express consent to corporate action in writingwithout a meeting, or entitled to receive payment of any dividend or other distribution or allotment of anyrights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for thepurpose of any other lawful action, the Board may Ñx, in advance, a record date, which shall not be more thansixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action.
(B) If no record date is Ñxed:
(1) The record date for determining stockholders entitled to notice of or to vote at a meeting ofstockholders shall be at the close of business on the day next preceding the day on which notice is given, or, ifnotice is waived, at the close of business on the day next preceding the day on which the meeting is held.
(2) The record date for determining stockholders for any other purpose shall be at the close of businesson the day on which the Board adopts the resolution relating thereto.
SECTION 4. Registered Shareholders. The Corporation shall be entitled to treat the holder of record of anyshare or shares of stock as the holder in fact thereof and, accordingly, shall not be bound to recognize anyequitable or other claim to or interest in such share on the part of any other person, whether or not it shall haveexpress or other notice thereof, save as expressly provided by the law.
SECTION 5. Lost CertiÑcates. Any person claiming a certiÑcate of stock to be lost or destroyed shall makean aÇdavit or aÇrmation of that fact and advertise the same in such manner as the Board may require, andthe Board may, in its discretion, require the owner of the lost or destroyed certiÑcate, or his legalrepresentative, to give the Corporation a bond, suÇcient to indemnify the Corporation against any claim thatmay be made against it on account of the alleged loss of any such certiÑcate. A new certiÑcate of the sametenor and for the same number of shares as the one alleged to be lost or destroyed may be issued withoutrequiring any bond when, in the judgment of the Board, it is proper so to do.
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ARTICLE VI.
EMERGENCY BYLAWS.
SECTION 1. When Operative. Notwithstanding any diÅerent provision in the preceding Articles of thebylaws or in the CertiÑcate of Incorporation, the emergency bylaws provided in this Article VI shall beoperative during any emergency resulting from an attack on the United States or on a locality in which theCorporation conducts its business or customarily holds meetings of its Board or its stockholders, or during anynuclear or atomic disaster, or during the existence of any catastrophe, or other similar emergency condition, asa result of which a quorum of the Board or a standing committee thereof cannot readily be convened foraction.
SECTION 2. Board Meetings. During any such emergency, a meeting of the Board may be called by anydirector or, if necessary, by any oÇcer who is not a director. The meeting shall be held at such time and place,within or without Cook County, Illinois, speciÑed by the person calling the meeting and in the notice of themeeting which shall be given to such of the directors as it may be feasible to reach at the time and by suchmeans as may be feasible at the time, including publication or radio. Such advance notice shall be given as, inthe judgment of the person calling the meeting, circumstances permit. Two directors shall constitute a quorumfor the transaction of business. To the extent required to constitute a quorum at the meeting, the oÇcerspresent shall be deemed, in order of rank and within the same rank in order of seniority, directors for themeeting.
SECTION 3. Amendments to Emergency Bylaws. These emergency bylaws may be amended, either beforeor during any emergency, to make any further or diÅerent provision that may be practical and necessary forthe circumstances of the emergency.
ARTICLE VII.
CONSENTS TO CORPORATE ACTION.
SECTION 1. Action by Written Consent. Unless otherwise provided in the CertiÑcate of Incorporation, anyaction which is required to be or may be taken at any annual or special meeting of stockholders of theCorporation, subject to the provisions of Sections (2) and (3) of this Article VII, may be taken without ameeting, without prior notice and without a vote if a consent in writing, setting forth the action so taken, shallhave been signed by the holders of outstanding stock having not less than the minimum number of votes thatwould be necessary to authorize or to take such action at a meeting at which all shares entitled to vote thereonwere present and voted; provided, however, that prompt notice of the taking of the corporate action without ameeting and by less than unanimous written consent shall be given to those stockholders who have notconsented in writing.
SECTION 2. Determination of Record Date for Action by Written Consent. The record date for determiningstockholders entitled to express consent to corporate action in writing without a meeting shall be Ñxed by theBoard of Directors of the Corporation. Any stockholder seeking to have the stockholders authorize or takecorporate action by written consent without a meeting shall, by written notice to the Secretary, request theBoard of Directors to Ñx a record date. Upon receipt of such a request, the Secretary shall, as promptly aspracticable, call a special meeting of the Board of Directors to be held as promptly as practicable. At suchmeeting, the Board of Directors shall Ñx a record date as provided in Section 213(b) (or its successorprovision) of the Delaware General Corporation Law; that record date, however, shall not be more than10 days after the date upon which the resolution Ñxing the record date is adopted by the Board nor more than15 days from the date of the receipt of the stockholder's request. Should the Board fail to Ñx a record date asprovided for in this Section 2, then the record date shall be the day on which the Ñrst written consent is dulydelivered pursuant to Section 213(b) (or its successor provision) of the Delaware General Corporation Law,or, if prior action is required by the Board with respect to such matter, the record date shall be at the close ofbusiness on the day on which the Board adopts the resolution taking such action.
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SECTION 3. Procedures for Written Consent. In the event of the delivery to the Corporation of a writtenconsent or consents purporting to represent the requisite voting power to authorize or take corporate actionand/or related revocations, the Secretary of the Corporation shall provide for the safekeeping of such consentsand revocations.
ARTICLE VIII.
MISCELLANEOUS PROVISIONS.
SECTION 1. Waiver of Notice. Whenever notice is required to be given, a written waiver thereof signed bythe person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent tonotice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except whenthe person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to thetransaction of any business because the meeting is not lawfully called or convened.
SECTION 2. Corporate Seal. The corporate seal shall have inscribed thereon the name of the Corporation,the year of its organization and the words ""Corporate Seal, Delaware''. The seal may be used by causing it or afacsimile thereof to be impressed or aÇxed or in any manner reproduced.
SECTION 3. Fiscal Year. The Fiscal Year of the Corporation shall be the calendar year.
SECTION 4. Records. The Bylaws and the proceedings of all meetings of the stockholders and the Boardshall be recorded in appropriate minute books provided for the purpose. The minutes of each meeting shall besigned by the Secretary or other oÇcer appointed to act as Secretary of the meeting.
SECTION 5. Amendments. The Bylaws may be added to, amended, altered or repealed at any regularmeeting of the Board, by a vote of a majority of the total number of the directors, or at any meeting ofstockholders, duly called and held, by a majority of the stock represented at such meeting.
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EXHIBIT 12
HSBC FINANCE CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
March 29 January 1Year ended through through Year ended December 31,
December 31, December 31, March 28,2004 2003 2003 2002 2001 2000
Ratio of earnings to combined Ñxedcharges and preferred stockdividends ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.86
(4) 1.91(5) 1.42 1.54(6) 1.65 1.62
(1) For Ñnancial statement purposes, these amounts are reduced for income earned on temporary investment of excess funds, generally
resulting from over-subscriptions of commercial paper issuances.(2) Represents one-third of rentals, which approximates the portion representing interest.(3) Preferred stock dividends are grossed up to their pretax equivalents.(4) The 2004 ratios have been negatively impacted by $121 million (after-tax) from the adoption of FFIEC charge-oÅ policies for our
domestic private label and MasterCard and Visa portfolios in December 2004 and positively impacted by the $423 million (after-tax)
gain on the bulk sale of our domestic private label receivables to HSBC Bank USA in December 2004. Excluding these items, our
ratio of earnings to Ñxed charges would have been 1.83 percent and our ratio of earnings to combined Ñxed charges and preferred stock
dividends would have been 1.77 percent. These non-GAAP Ñnancial ratios are provided for comparison of our operating trends only.(5) The 2003 ratios have been negatively impacted by the $167 million (after-tax) of HSBC acquisition related costs and other merger
related items incurred by HSBC Finance Corporation. Excluding these charges, our ratio of earnings to Ñxed charges would have been
1.89 percent and our ratio of earnings to combined Ñxed charges and preferred stock dividends would have been 1.82 percent. These
non-GAAP Ñnancial ratios are provided for comparison of our operating trends only.(6) The 2002 ratios have been negatively impacted by the $333 million (after-tax) settlement charge and related expenses and the
$240 million (after-tax) loss on the disposition of Thrift assets and deposits. Excluding these charges, our ratio of earnings to Ñxed
charges would have been 1.80 percent and our ratio of earnings to combined Ñxed charges and preferred stock dividends would have
been 1.76 percent. These non-GAAP Ñnancial ratios are provided for comparison of our operating trends only.
EXHIBIT 14
HSBC FINANCE CORPORATION
CERTIFICATION TO
CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS
Purposes
HSBC Finance Corporation (""HSBC Finance'' and, together with its subsidiaries, the ""Company'') expectsall of its employees to maintain the highest standards of ethical behavior and professional conduct inconnection with all of the Company's activities. To that end, the Company has adopted a Statement ofBusiness Principles that is applicable to all employees. The Chief Executive OÇcer, Chief Financial OÇcer,Chief Accounting OÇcer and Controller of HSBC Finance Corporation and the chief Ñnancial oÇcer andcontroller of each Company business unit (collectively, the ""Senior Financial OÇcers'') are expected tocomply with the Statement of Business Principles, including the provisions thereof relating to honest andethical conduct, conÖicts of interest and compliance with law. In addition to the Statement of BusinessPrinciples, the Senior Financial OÇcers are subject to the additional policies set forth in this Code of Ethics ofSenior Financial OÇcers (this ""Code of Ethics''), which is intended to supplement the Statement of BusinessPrinciples.
This Code of Ethics provides fundamental principles to which the Senior Financial OÇcers are expected toadhere. These principles are designed to deter wrongdoing and to promote:
‚ Honest and ethical conduct, including the ethical handling of actual or apparent conÖicts of interestbetween personal and professional relationships;
‚ Full, fair, accurate, timely and understandable disclosure in reports and documents that the CompanyÑles with, or submits to, the Securities and Exchange Commission (the ""SEC'') and in other publiccommunications made by the Company;
‚ Compliance with applicable governmental laws, rules and regulations;
‚ The prompt internal reporting to an appropriate person or persons identiÑed in this Code of Ethics ofviolations of this Code of Ethics; and
‚ Accountability for adherence to this Code of Ethics.
Financial Reporting and Disclosure
It is the responsibility of each Senior Financial OÇcer to promote full, fair, accurate, timely and understanda-ble disclosure in the reports and documents the Company Ñles with or submits to the SEC. The Companystrives to provide disclosure to the investment community that not only conforms with applicable rules of theSEC, but that also fairly presents to investors the Ñnancial condition and results of operations of the Company.
Because of their essential role in corporate governance, each Senior Financial OÇcer must seek to promoteethical behavior by other Company oÇcers and employees involved in Ñnancial reporting. It is theresponsibility of each Senior Financial OÇcer, therefore, to report any untrue statement of a material fact andany omission of a material fact of which such Senior Financial OÇcer becomes aware that aÅect thedisclosures made by the Company in its public Ñlings.
Internal and Disclosure Controls
It is the responsibility of each Senior Financial OÇcer to report any information of which such SeniorFinancial OÇcer becomes aware concerning (a) signiÑcant deÑciencies in the design or operation of theCompany's disclosure and internal controls that could adversely aÅect the ability of employees of the
Company to record, process, summarize and report Ñnancial data or (b) any fraud, whether or not material,that involves any employee who has a signiÑcant role in the Company's disclosure and internal controls.
Compliance with Law
It is the responsibility of each Senior Financial OÇcer to report any information of which such SeniorFinancial OÇcer becomes aware concerning evidence of a material violation by the Company or any employeeor agent of the Company of securities or other laws, rules or regulations applicable to the Company and theoperation of its businesses.
Reporting Violations
The Chief Executive OÇcer, Chief Financial OÇcer, Chief Accounting OÇcer and Controller of HSBC Fi-nance must report any information of which such Senior Financial OÇcer becomes aware concerning aviolation of this Code of Ethics promptly to the Internal Audit Department, the General Counsel of HSBCFinance Corporation or the Audit Committee of the Board of Directors. All other Senior Financial OÇcersmust report any information of which such Senior Financial OÇcer becomes aware concerning a violation ofthis Code of Ethics promptly to (a) such Senior Financial OÇcer's immediate supervisor and the InternalAudit Department, (b) the General Counsel of HSBC Finance or (c) the Audit Committee of the Board ofDirectors. Each Senior Financial OÇcer may report violations directly to the Audit Committee of the Boardof Directors, and must do so if such Senior Financial OÇcer has reason to believe that (i) such SeniorFinancial OÇcer's immediate supervisor or the Internal Audit Department is involved with the matter or(ii) the matter has not been appropriately addressed in a timely manner.
Consequences of Violations
The Audit Committee of the Board of Directors will determine, or designate appropriate persons to determine,appropriate actions to be taken in the event of violations of this Code of Ethics, which actions will be designedto deter wrongdoing and promote accountability for adherence to this Code of Ethics. Accordingly, anyviolation of this Code of Ethics may result in disciplinary action up to and including, but not limited to, thefollowing:
‚ Suspension or termination of employment;
‚ Pursuit of any and all remedies available to the Company for any damages or harm resulting to theCompany from a violation, including injunctive relief; and
‚ Referral of matters to appropriate legal or regulatory authorities for investigation and prosecution.
Requests for Waivers and Changes in Code of Ethics
Waivers of this Code of Ethics may only be granted by the Audit Committee of the Board of Directors ofHSBC Finance Corporation. The Audit Committee will not grant waivers except under extraordinarycircumstances. Any waivers that are granted must be publicly disclosed on a timely basis. In addition, anychanges to this Code of Ethics must be publicly disclosed on a timely basis.
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Quarterly CertiÑcations
Each Senior Financial OÇcer will be required to certify quarterly and in writing such Senior FinancialOÇcer's compliance with this Code of Ethics during the preceding calendar quarter.
I HEREBY CERTIFY THAT I HAVE READ THE CODE OF ETHICS FOR SENIOR FINANCIAL
OFFICERS OF HSBC FINANCE CORPORATION AND THAT I HAVE COMPLIED WITH THE
CODE OF ETHICS DURING THE CALENDAR QUARTER ENDED , 200 .
By:
Title:
Unit:
Date:
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Exhibit 23
Consent of Independent Registered Public Accounting Firm
To the Board of Directors of HSBC Finance Corporation:
We consent to the incorporation of our report dated February 28, 2005, included in this Annual Report onForm 10-K of HSBC Finance Corporation (the Company) (formerly Household International, Inc.) as ofDecember 31, 2004 (successor basis) and December 31, 2003 (successor basis) and for the year endedDecember 31, 2004 (successor basis), for the period January 1, 2003 through March 28, 2003 (predecessorbasis) and March 29, 2003 through December 31, 2003 (successor basis) and for the year endedDecember 31, 2002 (predecessor basis), into the Company's previously Ñled Registration StatementsNo. 2-86383, No. 33-21343, No. 33-45454, No. 33-45455, No. 33-52211, No. 33-58727, No. 333-00397,No. 33-44066, No. 333-03673, No. 333-39639, No. 333-58287, No. 333-58289, No. 333-58291,No. 333-47073, No. 333-36589, No. 333-30600, No. 333-50000, No. 333-70794, No. 333-71198,No. 333-83474 and No. 333-99107 on Form S-8 and Registration Statements No. 333-70744, No. 333-60510,No. 333-01025, No. 333-47945, No. 333-59453, No. 333-82119, No. 333-45740, No. 333-56152,No. 333-73746, No. 333-75328, No. 333-85886, No. 333-33240, No. 333-61964, No. 333-111413,No. 333-53862, No. 333-33052, No. 333-72453, No. 333-60543, No. 333-64175, No. 333-120494,No. 333-120495, No. 333-120496, and No. 333-100737 on Form S-3.
Our report dated February 28, 2005 contains an explanatory paragraph that states eÅective March 28, 2003,HSBC Holdings plc acquired all of the outstanding stock of Household International, Inc. (now HSBCFinance Corporation) in a business combination accounted for as a purchase. As a result of the acquisition,the consolidated Ñnancial information for the period after the acquisition is presented on a diÅerent cost basisthan that for the periods before the acquisition and, therefore, is not comparable.
Our report dated February 28, 2005 also contains an explanatory paragraph that states that HSBC FinanceCorporation has restated its consolidated Ñnancial statements as of December 31, 2003 (successor basis) andfor the period March 29, 2003 through December 31, 2003 (successor basis).
/s/ KPMG LLP
Chicago, IllinoisFebruary 28, 2005
Exhibit 31
CertiÑcation of Chief Executive OÇcer
I, William F. Aldinger, Chairman and Chief Executive OÇcer of HSBC Finance Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in light of the circumstancesunder which such statements were made, not misleading with respect to the period covered by thisannual report;
3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in thisannual report, fairly present in all material respects the Ñnancial condition, results of operations andcash Öows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying oÇcer and I are responsible for establishing and maintainingdisclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) forthe registrant and we have:
a) designed such disclosure controls and procedures, or caused such disclosure controls andprocedures to be designed under our supervision, to ensure that material information relating tothe registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this annual report is being prepared;
b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented inthis annual report our conclusions about the eÅectiveness of the disclosure controls andprocedures, as of the end of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's internal control over Ñnancialreporting that occurred during the registrant's most recent Ñscal quarter that has materiallyaÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancialreporting; and
5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation, tothe registrant's auditors and the audit committee of the registrant's board of directors (or personsperforming the equivalent functions):
a) all signiÑcant deÑciencies and material weaknesses in the design or operation of internal controlsover Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability torecord, process, summarize and report Ñnancial information; and
b) any fraud, whether or not material, that involves management or other employees who have asigniÑcant role in the registrant's internal control over Ñnancial reporting.
Date: February 28, 2005
/s/ W. F. ALDINGER
William F. AldingerChairman and Chief Executive OÇcer
Exhibit 31
CertiÑcation of Chief Financial OÇcer
I, Simon C. Penney, Senior Executive Vice President and Chief Financial OÇcer of HSBC FinanceCorporation, certify that:
1. I have reviewed this annual report on Form 10-K of HSBC Finance Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in light of the circumstancesunder which such statements were made, not misleading with respect to the period covered by thisannual report;
3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in thisannual report, fairly present in all material respects the Ñnancial condition, results of operations andcash Öows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying oÇcer and I are responsible for establishing and maintainingdisclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) forthe registrant and we have:
a) designed such disclosure controls and procedures, or caused such disclosure controls andprocedures to be designed under our supervision, to ensure that material information relating tothe registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this annual report is being prepared;
b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented inthis annual report our conclusions about the eÅectiveness of the disclosure controls andprocedures, as of the end of the period covered by this report based on such evaluation; and
c) disclosed in this annual report any change in the registrant's internal control over Ñnancialreporting that occurred during the registrant's most recent Ñscal quarter that has materiallyaÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancialreporting; and
5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation, tothe registrant's auditors and the audit committee of the registrant's board of directors (or personsperforming the equivalent functions):
a) all signiÑcant deÑciencies and material weaknesses in the design or operation of internal controlsover Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability torecord, process, summarize and report Ñnancial information; and
b) any fraud, whether or not material, that involves management or other employees who have asigniÑcant role in the registrant's internal control over Ñnancial reporting.
Date: February 28, 2005
/s/ S. C. PENNEY
Simon C. PenneySenior Executive Vice Presidentand Chief Financial OÇcer
Exhibit 32
CertiÑcation Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The certiÑcation set forth below is being submitted in connection with the HSBC Finance Corporation(the ""Company'') Annual Report on Form 10-K for the Ñscal year ended December 31, 2004 as Ñled with theSecurities and Exchange Commission on the date hereof (the ""Report'') for the purpose of complying withRule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the ""Exchange Act'') andSection 1350 of Chapter 63 of Title 18 of the United States Code.
I, William F. Aldinger, Chairman and Chief Executive OÇcer of the Company, certify that:
1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act;and
2. the information contained in the Report fairly presents, in all material respects, the Ñnancialcondition and results of operations of HSBC Finance Corporation.
February 28, 2005
/s/ W. F. ALDINGER
William F. AldingerChairman and Chief Executive OÇcer
Exhibit 32
CertiÑcation Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The certiÑcation set forth below is being submitted in connection with the HSBC Finance Corporation(the ""Company'') Annual Report on Form 10-K for the Ñscal year ended December 31, 2004 as Ñled with theSecurities and Exchange Commission on the date hereof (the ""Report'') for the purpose of complying withRule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the ""Exchange Act'') andSection 1350 of Chapter 63 of Title 18 of the United States Code.
I, Simon C. Penney, Senior Executive Vice President and Chief Financial OÇcer of the Company,certify that:
1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act;and
2. the information contained in the Report fairly presents, in all material respects, the Ñnancialcondition and results of operations of HSBC Finance Corporation.
February 28, 2005
/s/ S. C. PENNEY
Simon C. PenneySenior Executive Vice Presidentand Chief Financial OÇcer
EXHIBIT 99.1
HSBC FINANCE CORPORATION AND SUBSIDIARIES
DEBT AND PREFERRED STOCK SECURITIES RATINGS
Standard & Moody'sPoor's Investors
Corporation Service Fitch, Inc.
At December 31, 2004
HSBC Finance Corporation
Senior debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A A1 AA¿
